prpri No enabling mechanism in Rule 5(a) mandating an adjustment to disclosed profits No enabling mechanism in Rule 5(a) mandating an adjustment to disclosed profits

Case Law Details

Case Name : The Oriental Insurance Co. Ltd. Vs DCIT (ITAT Delhi)
Appeal Number : ITA No. 4535/Del/2016
Date of Judgement/Order : 30/06/2021
Related Assessment Year : 2010-11

The Oriental Insurance Co. Ltd. Vs DCIT (ITAT Delhi)

The assessee is aggrieved by the action of the AO in making a disallowance of Rs 56,59,609/- on account of Provision made for Standard Assets.

It was submitted that as per the scheme of taxing income of the assessee is to be computed as per provisions of section 44 read Rule 5 of Schedule 1. provisions, the audited annual accounts of the assessee are to be treated as sacrosanct and only the adjustments provided for in Rule 5 of the First Schedule are permissible. It was submitted that under Rule 5 there is no enabling provision which directs for disallowance of provision made for Standard Assets.

The Ld. first appellate authority has upheld the disallowance by relying on the appellate order passed by him in the case of the assessee for AY 2011-12. The Ld AR has filed a copy of the appellate order dated 16th November 2015 passed by the Ld CIT (A) in its case in appeal No. 40/13-14. The Ld. CIT (A) has upheld the disallowance.

Before us it was submitted by the Ld AR that the lower authorities have erred in making/sustaining the disallowance. In this regard it was submitted by the Ld. AR that the total income of the assessee is to be computed as per provisions of section 44 read Rule 5 of Schedule 1. It was submitted that as per the scheme of taxing provisions, the audited annual accounts of the assessee are to be treated as sacrosanct and only the adjustments provided for in Rule 5 of the First Schedule are permissible. It was submitted that under Rule 5 there is no enabling provision which directs for disallowance of provision made for Standard Assets.

We have carefully considered the facts of the case and the material available on record. The assessee is engaged in the business of General Insurance. Its taxability is governed by provisions of section 44 of the Act.

First Schedule to the Income Tax Act is divided into two parts, viz., Part A which is applicable to Life Insurance Business and Part B which is applicable to insurance companies other than life insurance.

Owing to the non obstante clause in section 44 all other provisions relating to the computation of total income stand excluded and the process of computation of the total income of the assessee requires firstly, picking up the figure of profit disclosed by the Profit and Loss Account and then making adjustments as per clauses (a) and (c) of Rule 5. Section 44 read with Rule 5 of the First Schedule makes the figure of profit disclosed by the Profit and Loss account drawn as per the Insurance Act as absolute and binding. Only the adjustments specified in clauses (a) and (c) can be given effect to while computing the total income.

At this stage it will be relevant to understand the nature of Provision made for Standard Assets. The Ld AR has filed before us copy of Prudential Norms issued by Insurance Regulatory and Development Authority (IRDA). It is submitted that “Provision for Standard Assets” has been made as per IRDA mandate. IRDA has issued “Guidelines on Prudential Norms for Income Recognition, Asset Classification, Provisioning and Other Related Matters in respect of Loans and Advances”.

The moot issue now to be deliberated upon is whether Rule 5 prescribes for an adjustment by adding back the provision made for standard assets?

Clearly, clauses (b) and (c) of Rule 5 are not relevant. Rule 5(b) is applicable w.e.f. from AY 2011-12. Even otherwise, Rule 5(b) prescribes for an adjustment on account of profit or loss vis a vis investments. Rule 5(c) again is not relevant as it deals with reserve for unexpired risk.

Prior to the amendment made by Finance (No. 2) Act 1998 with retrospective effect from 01st April 1989, Rule 5(a) restricted adjustment only vis a vis “expenditure or allowance….not admissible under the provisions of section 30 to 43B”. Finance (No. 2) Act 1998 expanded the scope of adjustment even to “amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed”. A literal reading of the first part of Rule 5(a) makes it clear that in order to attract the applicability of the said provision the amount should either be an “expenditure” or an “allowance” and secondly, the “expenditure” or “allowance” should be one not admissible under the provisions of sections 30 to 43A of the Act. Hon’ble Apex Court in case of General Insurance Corporation reported in 240 ITR 139(SC) has held that amount set apart for redemption of preference shares cannot be treated as expenditure in ordinary commercial sense of the term and as such, it cannot be added back for computing profits and gains of business including it in ‘expenditure not admissible under provisions of sections 30 to 43A’ by reference to rule 5(a) of First Schedule.

As noted above, “Provision made for Standard Asset” is a reserve made for Contingent Loss and is not “expenditure”. It can also not be an “allowance” as “allowances” are statutorily prescribed in the Act, for example Depreciation Allowance u/s 32 and Investment Allowance u/s 32A.

Now let’s deliberate upon the second part of Rule 5(a) which prescribes for an adjustment on account of “provision for any tax, dividend, reserve or any other provision as may be prescribed which is not admissible under the provisions of sections 30 to 43B”. Although in the instant case the amount debited to profit and loss account is termed as “Provision for Doubtful Assets”, however in substance it is a “Reserve” and not a “Provision”.

Finance (No. 2) Act 1998 has expanded the scope of adjustment even to “amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed”.

As a result, we find that there is no enabling mechanism in Rule 5(a) mandating an adjustment to disclosed profits by making an addition on account of provision made for Standard Assets. The Ld. CIT (DR) has relied upon decision of the coordinate bench of this Tribunal in case of Chaitanya Godavari Grameena Bank (supra). However, in that case the assesee was a bank and had claimed deduction on account of Provision for Standard Assets u/s 36(1)(viia). This was not a case of an Insurance Company to which provisions of Rule 5 was applicable. As already held above, under Rule 5 the Statute makes profit disclosed in Profit and Loss account sacrosanct subject only to adjustments prescribed in Rules 5(a) to 5(c). The case law relied is, therefore, distinguishable. The Ld. CIT (A), in AY 2011-12, has also not properly addressed the issue. Relevant statutory provisions have been inadvertently misread and hence not properly understood. We therefore delete the disallowance and for reasons given by us above Ground is allowed.

FULL TEXT OF THE ITAT JUDGEMENT

The present appeal has been filed by the assessee against the order dated 21st June 2016 passed by the Ld. Commissioner of Income Tax (Appeals) – 22, New Delhi {CIT (A for Assessment Year 2010-11.

2.0 Facts in brief are that for the year under consideration, the assessee had filed the return of income declaring total loss of Rs 4,44,00,88,739/- and book profit of Rs 83,72,07,564/- under section 115JB of the Income Tax Act, 1961 (hereinafter called ‘the Act’). The return was processed under section 143(1) of the Act. Thereafter, the case was selected for scrutiny assessment u/s 143(3) of the Act and vide order of assessment dated 28th February 2013, the Assessing Officer (AO) assessed the total income of the assessee at Rs 2,24,18,46,485/-under normal provisions of the Income Tax Act, 1961 and book profit of Rs 1,71,06,49,743/- u/s 115JB of the Act. The AO completed the assessment under section 143(3) by making the following additions:

i. Profit on sale of investment – Rs. 5,35,25,23,496/-

ii. Interest not provided as Income – Rs. 92,00,59,000/-

iii. Disallowance of Depreciation – Rs.1,47,75,105/-

iv. Guest House Expenses disallowed – Rs. 46,07,965/-

v. Disallowance under section 14A – Rs. 38,43,09,793/-

vi. Provision for Standard Asset Disallowed – Rs 56,59,609/-

2.1 Being aggrieved by the assessment order passed, the assessee preferred appeal before Ld. CIT (A). The Ld. CIT (A), vide the impugned order, gave partial relief to the assessee by confirming certain additions made by the AO.

2.2 Aggrieved by the order of the Ld. CIT (A), the assessee is in appeal before us now. To the extent disallowances/ additions were deleted by the Ld CIT (A), revenue preferred an appeal before this Tribunal (ITAT) which stands dismissed vide order dated 22nd October 2019 in ITA No. 4818/Del/2016.

2.3  The assessee has raised the following grounds of appeal:

“1. That on the facts and in law the CIT (A) erred in upholding an addition to total income of Rs.561,92,07,000(i.e., Rs.535,25,23,496/- and Rs.26,66,83,544/-) on account of Profit on Sale/Redemption of Investments.

1.1 That on the facts and in law the CIT (A)/AO erred in not appreciating that by virtue of CBDT Circular No.528 dated 16th December, 1988 income earned by the appellant from Profit on Sale/Redemption of investments is not liable to tax.

2.1 Without prejudice, on facts and in law the CIT (A)/AO erred in not appreciating that Profit on Sale/Redemption of Investments will be chargeable to tax as income under the head “Capital Gains”.

2.1  Without prejudice, that on the facts and in law the CIT (A) erred in upholding the action of AO in denying benefit of exemption u/s 10(38) of the Income Tax Act.

2.2  Without prejudice, on the facts and in law the CIT (A) erred in upholding the action of AO in denying benefit of concessional rate of tax as per section 111A and / or section 112 of the Income Tax Act.

3. That on facts and in law the CIT (A)/AO erred in upholding a disallowance of Rs.1,47,75,105/- out of the total depreciation allowance claimed by the appellant under section 32 of the Act. 3.1 That on the facts and in law the AO/CIT (A) erred in making / upholding the above disallowance without considering the fact that unlike earlier years assessments / appeals all necessary details relevant to depreciation allowance claim for AY 2010-11 were on record.

3.1 That on the facts and in law the CIT (A) erred in upholding a disallowance of Rs.56,59,609/- being provision made for standard assets.

4. That on the facts and in law the CIT (A) erred in not adjudicating upon ground nos.7 and 8 raised by the appellant in the appeal memo before him.

5. That on the facts and in law the CIT (A) erred in upholding levy of interest under sections 234B and 234D of the Income Tax Act.

6. That on the facts and in law the order of assessment u/s 143(3) passed by the Assessing Officer {hereinafter referred to as the “AO”] is bad in law and void ab-initio.

7. That on the facts and in law the order passed by Commissioner of Income Tax {hereinafter referred to as the “CIT (A)”] to the extent it upholds the assessment order in part is bad in law and void ab-initio.”

2.4 Grounds 6, 7 and 8 above have been renumbered by us as there was a numbering error in the memo of appeal filed by the assessee.

3.0 During the course of hearing before us, the Ld AR fairly stated that ground nos 7 and 8 are general in nature. As regards ground no. 6 again it was fairly admitted that the levy of interest u/s 234B and 234D of the Act will be consequential. Since no specific relied is claimed grounds 6, 7 and 8, the same are dismissed.

4.0 Ground No.1 raised by the assessee is in respect of addition on account of profit on sale/redemption of investments at Rs. 561,92,07,000/-. Briefly stated, the relevant facts that in the return of income, the assessee had claimed profit derived from sale/ redemption of investments to the tune of Rs 535.25 crores as exempt by relying upon CBDT Circular No. 528 dated 16th December 1988. Thereafter, during the course of assessment, revised computation of income was filed by the assessee making a further claim of exemption of Rs 26.66 crores. Therefore, the subject matter of dispute before the Ld CIT (A) was whether the entire amount of Rs 561.92 crores (i.e. Rs 535.25 crores + Rs 26.66 crores) was exempt from tax while computing the total income of the assessee.

4.1 Before us, the Ld. AR, at the outset submitted that the issue as to whether profit derived by the assessee from sale/ redemption of investments is exempt from tax is a legacy issue. In earlier years too similar additions were made by the lower authorities and the matter now stands settled by the decision of the Hon’ble Jurisdictional High Court in case of assessee for AY 2005­06 reported in 407 ITR 658 (Del).

4.2 The Ld. CIT (DR), on the other hand, has not been able to controvert this and has relied upon the orders passed by the lower authorities making / sustaining the addition.

5.0 We have carefully considered the facts of the case and the material available on record. It is observed that the question raised before the Hon’ble High Court was framed for determination as under:-

Whether the ITAT was correct in law in holding that the income earned on sale/redemption of investments is chargeable to tax?”

5.1 We have perused the decision of the Hon’ble High Court and note that the issue has been duly deliberated upon in paragraphs 25 to 49 of the said order. The relevant portion of the order where the Hon’ble High Court has concluded and opined upon the issue is reproduced hereunder:

“42. The above approach of the AO in relation to Circular No. 528 and its binding nature as far as the Revenue is concerned, appears to be flawed. In Principal Commissioner of Income Tax v. National Insurance Co. Ltd. [2017] 393 ITR 52/246 Taxman 176/79 taxmann.com 112 (Cal.), it was held that Circular No. 528 of 1988 did not permit the AO to add back the profits arising from the sale of investments made by the Assessee in that case which was also carrying on a general insurance business. The Calcutta High Court in the above decision referred to the decision in Paper Products Ltd. v. Commissioner of Central Excise [2001] 247 ITR 128/115 Taxman 147 (SC) where it was held that the circulars issued under Section 37B of the Central Excise Act, 1944 would be binding on the Department and that, “it does not lie in the mouth of the Revenue to repudiate a circular issued by the Board on the basis that it is inconsistent with the statutory provisions. Consistency and discipline are, according to this Court, of far greater importance than the winning or losing of Court proceedings.” It is, therefore, too late in the day for the Revenue to disown its own Circular No. 528 and contend that it does not apply to the facts of the present case.

43. In CIT v. Ashok Mittal [2013] 357 ITR 245/31 taxmann.com 240/213 Taxman 197 (Mag.) (Delhi), the Court reiterated the well settled position that, where the CBDT circular has not been withdrawn and is beneficial to the Assessee, it would be binding on the AO and other Revenue authorities. The Court was merely reiterating what has been held in a large number of cases including Navnitlal C. Zaveri (supra) and CIT v. Milk Food Ltd. [2006] 280 ITR 331/152 Taxman 50 (Delhi).

44. The ITAT itself has taken a consistent stand that the taxability of income in the case of insurance companies is not on commercial profits but on such profits as are computed in accordance with the provisions of the IA, subject to the permissible adjustments under the Act. In other words, the taxability of profits in the hands of the insurance companies is confined to profits in terms of annual accounts of such insurance companies drawn up in accordance with the IA.

45. Indeed, the legislative policy appears to be clear. Where it is intended to bring the profit on sale of investments to tax, the legislature has chosen to re-introduce the earlier provision by virtue of the amendment effective from AY 2011-12. The intention behind omitting Rule 5(b) was clearly expressed in the Circular. If the Circular was not intended to fill the gap brought about by the omission of Rule 5(b), viz., to exempt the profits on sale of investments made by the insurance companies from tax, there was no need to re-introduce Rule 5(b) with effect from AY 2011-12. The resultant position is that for the period during which there was no Rule 5(b) the profits on sale of investments were not taxable in the hands of the Assessee. Further, the Assessee has itself clarified that it is not claiming the loss suffered on the writing off of the investments in compliance with the CBDT Circular No. 528.

46. The different benches of the ITAT have, in other cases consistently held that during the period when Rule 5(b) was not operational the profit on sale of investments made by general insurance companies cannot be brought to tax. In Bajaj Allianz General Insurance Co. Ltd. vs. Additional Commissioner of Income Tax (2010) 130 TTJ (Pune) 398, the ITAT addressed the specific question of whether a logical conclusion could be drawn that an income that is not taxed in terms of Rule 5(b) could, even after such amendment was deleted, be taxed in the hands of the insurance company. It was held that income which was earlier taxable under one specific clause could not be brought to tax after the deletion of such clause.

47. It is futile, therefore, for the Revenue to seek to bring to tax profits on sale of investment because in some earlier year the Assessee may have taken what appears to DC a contradictory stand. In any event, the assessee appears to have explained that the issue that arose in the earlier case was regarding investments written off-and not profit on sale/redemption of investments. The observations of ITAT in its order for AY 1990­91 with regard to the profit on sale/redemption of investment could, at best, be treated as obiter since that was not in issue in the case before it.

48. The Court is, therefore, liable to subscribe to the submission of Mr. Manchanda that the Circular No.518 has no application to the present case. The deicison in J.K. Synthetics v. CBDT (supra) relied upon by him has no application to the facts of the case. Furthermore, it is not even the case of the Revenue that the said Circular is ultra vires of the Act.

49. The question framed in ITA No.372 of 2015 is accordingly answered in the negative in favour of the assessee and against the revenue, by holding that the itat erred in holding that the income earned on sale/redemption of investment was chargeable to tax.”

5.2 On the basis of the above, we do not find any reason to deviate from the view taken by the Hon’ble High Court as the assessee has taken identical pleas regarding profit on sale of investment being exempt as the same is not covered by section 44 of the Income Tax Act. The Hon’ble High Court has also observed that legislative intention is clear. Where the Legislature intended to bring the profit on sale of investments to tax, it has chosen to re­introduce the earlier provision by virtue of the amendment effective from Assessment Year (AY) 2011-12. Since there is no difference in the facts for the year under consideration vis-a-vis assessment year 2005-06 and considering that the present case before us pertains to AY 2010-11, respectfully following the ratio laid down by the Hon’ble High Court we allow this ground raised by assessee. Accordingly the Ground Nos. 1 and 1.1 are allowed.

6.0 Ground Nos. 2, 2.1 are in respect of denial of exemption under section 10(38) of the Act, whereas Ground No. 2.2 seeks benefit of concessional rate of tax u/s 111A / 112 of the Income Tax Act. These are alternative claims raised by the assessee. In our considered opinion, these grounds now become in fructuous in view of our adjudication in Ground Nos. 1 and 1.1 above which has been decided in favour of the assessee. Grounds 2, 2.1 and 2.2 are accordingly dismissed.

7.0 Ground Nos. 3 and 3.1 relate to the disallowance of depreciation of Rs 1,47,75,105/-. The Assessing Officer (AO), while dealing with this issue in the assessment proceedings, has observed that similar disallowance estimated at the rate of 29% was made from AYs 2000-01onwards. Disallowance made for AY 2000-01 has also been confirmed by this Tribunal. The AO, following the similar view, as the facts prevalent were identical, disallowed depreciation @ 29% for the year under consideration.

7.1 Before us, the Ld AR submitted that during the assessment year 2000-01, the assessee had not filed any details regarding the assets on which the depreciation was claimed. He submitted that this Tribunal, for assessment year 2000-01 and 2001-02 vide order dated 27th February 2009 reported in 130 TTJ 338 (Del), upheld the addition by observing as under:-

“34. We have carefully gone through the records and considered the rival contentions. We agree with the reasoning given by the CIT (A) in sustaining the disallowance. If the assessee claims to have made addition to the assets, it is obligatory on its part to give all the details of such assets added, to the AO so that he may scrutinize them and allow depreciation as per the provisions of law. The assessee has not given the basic details, therefore, the question of allowing any depreciation on such assets cannot be accepted. We endorse the findings of the CIT (A), having regard to the facts and circumstances of the case.”

7.2 The Ld. AR, adverting to the facts in the present case, submitted that admittedly for the year under consideration the assessee has submitted all the relevant information in respect of the assets for which depreciation has been claimed. In this regard the Ld AR invited our attention towards Statement of Facts wherein it is stated as under:

“ The Learned Assessing Officer has disallowed a sum of Rs 1,47,75,105/- being 29% of the depreciation amounting to Rs 5,09,48,638/- claimed by the appellant in the return of income. The learned assessing officer erred in taking the stand taken in the earlier years and following the same formulae used in the previous years.

The learned Assessing Officer has erred in comparing facts of the captioned assessment year with that of earlier assessment years and has made the disallowance without appreciating the details filed 17.12.2012. It is also submitted that the learned Assessing Officer has followed the appellant orders for the earlier years wherein estimated 29% of the depreciation allowance was disallowed on the ground that details of addition to assets was not furnished. However, during the year requisite details were filed and the particulars of same are disclosed in Annexure of the Tax Audit report for the captioned year. Thus, the dissonance in the captioned year is without any basis and material on record. The addition if any is to be based on facts of each year as every assessment year is distinct and separate for purpose of assessment.”

7.3 The Ld. AR submitted that both the lower authorities had decided the issue by blindly following the precedents decided in the past and ignoring the factual details submitted during assessment. It was, therefore, prayed by the Ld. AR that in interest of justice the issue may be set aside to the AO for verification of the details filed, along with the audit report which is a part of record.

8.0 The Ld. DR supported the order passed by the Ld. CIT (A).

9.0 We have carefully perused the orders of the lower authorities and the material available on record. It is seen that similar issue arose before this Tribunal in the case of the assessee for AY 2007-08 in ITA No. 5796/Del/2015. Vide order dated 12th January 2018, the coordinate bench of this Tribunal held as under:

“6.8 As we compare the factual position prevalent during assessment year 2000-01 and 2001-02 based on which the Tribunal confirmed the disallowance of depreciation, we observe that it was so decided because assessee failed to furnish relevant information before the Assessing Officer along with Audit Report. Facts of the present assessment year are different as Ld. AR sufficiently demonstrated that the details were very much available before Ld. AO and Assessing Officer has not taken any steps to verify the same.

6.9 We therefore are inclined to set aside this issue to Ld. AO for proper verification of the details filed by assessee. Ld. AO is directed to decide the issue as per law after taking into consideration all the material facts available on record. Accordingly this ground raised by assessee stands allowed for statistical purposes.”

9.1 In the year under consideration also, the relevant details for addition made to fixed assets in Financial Year 2009-10 have been placed on record by the assessee. The AO has, however, failed to take the same into consideration. We are, therefore, inclined to set aside this issue to the records of the AO for a de novo verification of the relevant facts. In the result, Grounds 3 and 3.1 are partly allowed for statistical purposes.

10.0 In Ground No. 4 of the appeal, the assessee is aggrieved by the action of the AO in making a disallowance of Rs 56,59,609/- on account of Provision made for Standard Assets. In this regard, in the order of assessment, it has been held by the AO as under:

“During the year under reference, the assessee has made a provision for standard assets of Rs.56,59,609/-. When asked to explain as to why the same should not be allowed, the assessee made the following submission:

“As per IRDA’s CIRCULAR NO.32/F&A/Circulars/169/Jan/2006-07 dt.24.01.2007, Standard Asset is defined as under:

Standard asset is one which does not disclose any problem and which does not carry more than normal risk attached to the business. Such as asset is not an NPA. As per the same circular, the insurer should make a general provision on Standard Assets of a minimum of 0.40 per cent of the value of the asset. The change in provision from last year is taken to P&L A/c.

10.2 The reply of the assessee has been perused and carefully considered. As per the assessee’s own submission standard asset does not disclose any problem and does not carry more than normal risk and is not an NPA. The provision for standard assets of Rs.56,59,609/- is therefore disallowed. Penalty u/s 271(1)(c) is initiated for furnishing of inaccurate particulars of income and concealment of the particulars of income.”

10.1 The Ld. first appellate authority has upheld the disallowance by relying on the appellate order passed by him in the case of the assessee for AY 2011-12. The Ld AR has filed a copy of the appellate order dated 16th November 2015 passed by the Ld CIT (A) in its case in appeal No. 40/13-14. The Ld. CIT (A) has upheld the disallowance by observing as under:

“The AO has followed the order for AY10-11 on this issue. However, it needs to be mentioned here, there has been an amendment under rule 5 (supra), w.e.f., 01-04-2011, Under rule 5(a), the legislature has provided w.e.f., 01-04-2011, that any expenditure or allowance, which is not admissible under the provision of section 30 to 43B would include any amount debited to the P&L account by way of provisions. The appellant has relied on the decision of the Apex Court in the case of M/s Oriental Fire and General Insurance Company Ltd., reported in 291 ITR 370, wherein the Apex Court has held that the provision is deducted from an asset and is made against anticipated losses, while the reserve is an appropriation of profit and remains as proprietors interest in the balance sheet. The Apex Court further held that a provision made for bad and doubtful debts against an anticipated loss, is not an expenditure and since rule 5of first schedule of Income Tax Act provides for adding back of only an expenditure or allowance, the provision for bad and doubtful debts cannot be added back. The appellant also relied on the decision of the Apex Court in the case of General Insurance Corporation of India reported in 240 ITR 139. However, the said decision is also in respect of AY77-78 and it deals with the provision for redemption for preference shares, which was held to be not an expenditure covered by section 30 to section 43B.

5.2 In view of amendment to Rule 5 including rule 5(a) w.e.f., 01-04-2011, the decisions of the Apex Court relied upon by the appellant, no longer apply and the word ‘expenditure or allowed’ referred to in section 5(a) now includes provision, which is not admissible under the provisions of section 30 to section 438. without prejudice to the same, as per IRDA Circular dated 24-01-07 reported on page 15 of the assessment order, the standard asset is one which does not disclose any problem and which does not carry more than normal risk attached to the business and such assets is not on NPA. Therefore, the provision for Standard Asset is not even a provision for anticipated losses, referred to in the decision of the Apex Court reported in 291 ITR 370, as the provision in that case, was for bad and doubtful claims, I.e., an anticipated loss. In view of the same, even without considering the amendment to rule 5 and 5(a) w.e.f., 01.04.2011, the facts in the case of the appellant are distinguishable from the two decisions of the Apex Court, relied upon by the appellant. Moreover, since the Act has been amended w.e.f., 01.04.11, the provision for Standard Asset is to be added back even otherwise, in view of amended provision. Consequently, ground no. 7 of the appeal is dismissed.”

10.2 Before us it was submitted by the Ld AR that the lower authorities have erred in making/sustaining the disallowance. In this regard it was submitted by the Ld. AR that the total income of the assessee is to be computed as per provisions of section 44 read Rule 5 of Schedule 1. It was submitted that as per the scheme of taxing provisions, the audited annual accounts of the assessee are to be treated as sacrosanct and only the adjustments provided for in Rule 5 of the First Schedule are permissible. It was submitted that under Rule 5 there is no enabling provision which directs for disallowance of provision made for Standard Assets.

10.3 The Ld. CIT (DR), on the other hand, vehemently supported the disallowance made by the lower authorities. It was submitted that the Ld. CIT (A), in AY 2011-12, has justifiably sustained the disallowance. The Ld. CIT.(DR) also relied upon the decision of the coordinate bench of this Tribunal in case of Chaitanya Godavari Grameen Bank reported in 170 ITD 668(Vishaka).

11.0 We have carefully considered the facts of the case and the material available on record. The assessee is engaged in the business of General Insurance. Its taxability is governed by provisions of section 44 of the Act which provides as under:-

“44. Insurance business.—Notwithstanding anything to the contrary contained in the provisions of this Act relating to the computation of income chargeable under the head “Interest on securities”, “Income from house property”, “Capital gains” or “Income from other sources”, or in section 199 or in sections 28 to 43B, the profits and gains of any business of insurance, including any such business carried on by a mutual insurance company or by a co-operative society, shall be computed in accordance with the rules contained in the First Schedule.”

11.1 First Schedule to the Income Tax Act is divided into two parts, viz., Part A which is applicable to Life Insurance Business and Part B which is applicable to insurance companies other than life insurance. Rule 5 states as under:

“5. The profits and gains of any business of insurance other than life insurance shall be taken to be the profit before tax and appropriations as disclosed in the profit and loss account prepared in accordance with the provisions of the Insurance Act, 1938 (4 of 1938) or the rules made thereunder or the provisions of the Insurance Regulatory and Development Authority Act, 1999 (4 of 1999) or the regulations made thereunder, subject to the following adjustments:—

(a) subject to the other provisions of this rule, any expenditure or allowance including any amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed which is not admissible under the provisions of sections 30 to 43B in computing the profits and gains of a business shall be added back;

(b) (i) any gain or loss on realisation of investments shall be added or deducted, as the case may be, if such gain or loss is not credited or debited to the profit and loss account;

(ii) any provision for diminution in the value of investment debited to the profit and loss account, shall be added back;

(c) such amount carried over to a reserve for unexpired risks as may be prescribed in this behalf shall be allowed as a deduction.”

11.2 Owing to the non obstante clause in section 44 all other provisions relating to the computation of total income stand excluded and the process of computation of the total income of the assessee requires firstly, picking up the figure of profit disclosed by the Profit and Loss Account and then making adjustments as per clauses (a) and (c) of Rule 5. Section 44 read with Rule 5 of the First Schedule makes the figure of profit disclosed by the Profit and Loss account drawn as per the Insurance Act as absolute and binding. Only the adjustments specified in clauses (a) and (c) can be given effect to while computing the total income. The above legal position is now well settled, in case of assessee itself by the Hon’ble Apex Court in its judgment reported in 291 ITR 370(SC) as under:

“13. Insurance companies in view of the provisions of the said Act, however, are dealt with also under the 1961 Act differently. Section 44 thereof, as noticed hereinbefore, begins with a non obstante clause. The jurisdiction of the Income-tax Officer in passing the orders of assessment is limited. Keeping in view the fact that the business carried out by the assesse is not governed by the ordinary principles applicable to business computation as laid down in section 10 of the 1961 Act, the insurance companies do not compute their profits annually in the manner laid down therein.

A bare perusal of rule 5(a) of the 1961 Act would categorically demonstrate that ordinarily the annual accounts furnished before the Controller of Insurance would be taken to be the balance of the profits disclosed thereby. The same, however, is subject to the adjustments mentioned therein, namely, any expenditure or allowance which is not admissible under the provisions of sections 30 to 43A in computing the profits and gains of the business. If the said provision is found to be applicable, the amount may be added back.”

11.3 At this stage it will be relevant to understand the nature of Provision made for Standard Assets. The Ld AR has filed before us copy of Prudential Norms issued by Insurance Regulatory and Development Authority (IRDA). It is submitted that “Provision for Standard Assets” has been made as per IRDA mandate. IRDA has issued “Guidelines on Prudential Norms for Income Recognition, Asset Classification, Provisioning and Other Related Matters in respect of Loans and Advances”. IRDA has prescribed as under:

“3 GUIDELINES ON PRUDENTIAL NORMS FOR INCOME RECOGNITION, ASSET CLASSIFICATION, PROVISIONING AND OTHER RELATED MATTERS IN RESPECT OF LOANS & ADVANCES:

The guidelines are based on the RBI guidelines issued in this regard, duly modifying, keeping in view the industry specific requirements. Any item not covered below will be governed by the provisions as mandated by the RBI for banks.

3.1 Asset Classification

Adequate provision shall be made for estimated loss arising on account from/under recovery of loans and advances (other than loans and advances granted against insurance policies issued by the insurer) outstanding at the balance sheet date. Insurers shall classify their loans/advances into four categories, viz., (i) standard assets, (ii) sub-standard assets, (iii) doubtful assets and (iv) loss assets. Classification of assets into these categories shall be done taking into account ability of the borrower to repay and the extent of value and realizability of security

3.1.1 Standard assets

Standard asset is one which does not disclose any problem and which does not carry more than normal risk attached to the business. Such an asset is not an NPA. The insurer should make a general provision on Standard Assets of a minimum of 0.40 per cent of the value of the asset.”

11.4 The assessee has not denied the fact that Standard Assets do not disclose any problem and are not NPA. However, the prudential norms adopt a conservative view and mandate recognition of general provision in the books of accounts. “Provision made for Standard Asset” is therefore a reserve created for Contingent Loss and is not “expenditure”.

11.5 The moot issue now to be deliberated upon is whether Rule 5 prescribes for an adjustment by adding back the provision made for standard assets?

11.6 Clearly, clauses (b) and (c) of Rule 5 are not relevant. Rule 5(b) is applicable w.e.f. from AY 2011-12. Even otherwise, Rule 5(b) prescribes for an adjustment on account of profit or loss vis a vis investments. Rule 5(c) again is not relevant as it deals with reserve for unexpired risk. Rule 5(a) being relevant mandates an adjustment as under:

(a) subject to the other provisions of this rule, any expenditure or allowance including any amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed which is not admissible under the provisions of sections 30 to 43B in computing the profits and gains of a business shall be added back;”

11.7 Prior to the amendment made by Finance (No. 2) Act 1998 with retrospective effect from 01st April 1989, Rule 5(a) restricted adjustment only vis a vis “expenditure or allowance….not admissible under the provisions of section 30 to 43B”. Finance (No. 2) Act 1998 expanded the scope of adjustment even to “amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed”. A literal reading of the first part of Rule 5(a) makes it clear that in order to attract the applicability of the said provision the amount should either be an “expenditure” or an “allowance” and secondly, the “expenditure” or “allowance” should be one not admissible under the provisions of sections 30 to 43A of the Act. Hon’ble Apex Court in case of General Insurance Corporation reported in 240 ITR 139(SC) has held that amount set apart for redemption of preference shares cannot be treated as expenditure in ordinary commercial sense of the term and as such, it cannot be added back for computing profits and gains of business including it in ‘expenditure not admissible under provisions of sections 30 to 43A’ by reference to rule 5(a) of First Schedule. In this regard explaining the meaning of word “expenditure” it was held that:

“11. The term ‘expenditure’ came up for consideration of this Court in Indian Molasses Co (P) Ltd vs. CIT [1959] 37 ITR 66. It was held:

” ‘Spending’ in the sense of ‘paying out or away’ of money is the primary meaning of ‘expenditure’. ‘Expenditure’ is what is paid out or away and is something which is gone irretrievably. Expenditure, which is deductible for income-tax purposes, is one which is towards a liability actually existing at the time, but the putting aside of money which may become expenditure on the happening of an event is not expenditure.” (p. 66)

In Pandyan Insurance Co. Ltd. v. CIT [1965] 55 ITR 716 also this Court has held that ‘expenditure’ meant ‘disbursement’ and, hence, did not include depreciation.”

11.8 As noted above, “Provision made for Standard Asset” is a reserve made for Contingent Loss and is not “expenditure”. It can also not be an “allowance” as “allowances” are statutorily prescribed in the Act, for example Depreciation Allowance u/s 32 and Investment Allowance u/s 32A.

11.9 Now let’s deliberate upon the second part of Rule 5(a) which prescribes for an adjustment on account of “provision for any tax, dividend, reserve or any other provision as may be prescribed which is not admissible under the provisions of sections 30 to 43B”. Although in the instant case the amount debited to profit and loss account is termed as “Provision for Doubtful Assets”, however in substance it is a “Reserve” and not a “Provision”. The difference between the two is now well settled. In case of State Bank of Patiala v. CIT reported in 219 ITR 706(SC) it was held by the Hon’ble Apex Court that:

“A fair reading of the above decisions would go to show that if the transfer of amount is made ad hoc, when there is no known or anticipated liability, such fund will only be treated as reserve. In this case, substantial amounts were set apart as reserves. No amount of bad debts was actually written off or adjusted against the amount claimed as reserves. No claim for any deduction by way of bad debts were made during the relevant assessment years. The assessee never appropriated any amount against any bad and doubtful debts. The amounts throughout remained in the account of the assessee by way of capital and the assessee treated the said amounts as reserves and not as provisions designed to meet liability, contingency, commitment or diminution in the value of assets known to exist at the relevant dates of Balance sheets. These facts have been found by the Tribunal. On the facts, the amount set apart as reserves cannot be said to be so earmarked, when any liability has actually arisen or was anticipated by the assessee. It cannot be said either, that the amounts set apart out of the profits were designed to meet any known liability, that existed at the date of the Balance sheet. Tested in the light of the decisions of this Court, referred to hereinabove, it appears to us, that the amounts set apart towards bad and doubtful debts in these cases are reserves qualifying for appropriate relief under rule 1(xi)( b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act.”

11.10 Finance (No. 2) Act 1998 has expanded the scope of adjustment even to “amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed”. Apparently, “Provision made for Standard Assets” is neither:

(i) A provision for any tax,

(ii) A provision for any dividend,

(iii) Although statute has expanded scope of adjustment to “reserve or any other provision as may be prescribed, however till date no notification is issued by CBDT expanding such scope. Ld CIT(DR) has not brought on record any notification issued by CBDT in this regard.

11.11 As a result, we find that there is no enabling mechanism in Rule 5(a) mandating an adjustment to disclosed profits by making an addition on account of provision made for Standard Assets. The Ld. CIT (DR) has relied upon decision of the coordinate bench of this Tribunal in case of Chaitanya Godavari Grameena Bank (supra). However, in that case the assesee was a bank and had claimed deduction on account of Provision for Standard Assets u/s 36(1)(viia). This was not a case of an Insurance Company to which provisions of Rule 5 was applicable. As already held above, under Rule 5 the Statute makes profit disclosed in Profit and Loss account sacrosanct subject only to adjustments prescribed in Rules 5(a) to 5(c). The case law relied is, therefore, distinguishable. The Ld. CIT (A), in AY 2011-12, has also not properly addressed the issue. Relevant statutory provisions have been inadvertently misread and hence not properly understood. We therefore delete the disallowance and for reasons given by us above Ground No 4 is allowed.

12.0 In Ground No. 5 of the appeal, the assessee is aggrieved by the fact that the Ld. CIT (A) has erred in not adjudicating on ground numbers 7 and 8 raised by the assessee in the appeal memo filed before him. From records it is apparent that in Form 35 the assessee had challenged the assessment order on following grounds 7 and 8:

“7.    On the facts and in the circumstances of the case and in law the Ld Assessing Officer ought to have allowed carry forward of Rs 4,41,53,11,765/- under section 72(1) being business loss the captioned assessment year and Rs 29,14,60,122/- being unabsorbed depreciation allowance of the captioned assessment year under section 32(2), and not doing so is wrong and contrary to the facts and circumstances of the case, provisions of the Income Tax Act, 1961, and Rules made thereunder.

On the facts and in the circumstances of the case and in law, the Ld Assessing Officer ought to have allowed set off of business loss of earlier years brought forward u/s 72(1) and set off unabsorbed depreciation allowance brought forward from the earlier years u/s 32(2) against the total income determined for the captioned assessment year and not doing so is wrong and contrary to the facts and circumstances of the case, provisions of the Income Tax Act, 1961, and Rules made thereunder.”

13.0 A perusal of the impugned order passed by the Ld. CIT (A) depicts that inadvertently there is no adjudication by the Ld. first appellate authority on the above issues. Since the issues raised pertain to determination and carry forward of business loss and unabsorbed depreciation, we direct the AO to consider these issues on merits in accordance with law while giving effect to our order. As a result Ground No. 5 is partly allowed for statistical purposes.

14.0 In the final result the appeal filed by the assessee is therefore partly allowed for statistical purposes.

Order pronounced on 30th June, 2021.

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