Provision for Standard Assets Also Eligible for Deduction Under Section 36(1)(viia): ITAT Special Bench

Malwa Gramin Bank Vs DCIT (ITAT Chandigarh)

Provision for Standard Assets Also Eligible for Deduction Under Section 36(1)(viia): ITAT Special Bench

In an important ruling for banks and co-operative banks, the Special Bench of the Chandigarh Income Tax Appellate Tribunal has held that a provision created against standard assets in accordance with the mandatory prudential norms prescribed by the Reserve Bank of India is eligible for deduction under section 36(1)(viia) of the Income-tax Act, 1961.

The fact that standard assets are presently performing or income-generating assets does not take the provision outside section 36(1)(viia). Even standard assets carry an inherent credit risk and may become bad in future. However, the deduction remains subject to the provision actually created in the books and the overall monetary ceiling prescribed under section 36(1)(viia).

The ruling was delivered in the case of M/s Malwa Gramin Bank, now merged with Punjab Gramin Bank v. DCIT, covering Assessment Years 2011-12, 2012-13, 2014-15 and 2015-16.

Issue Before the Special Bench

Conflicting decisions existed among different Benches of the Tribunal on whether a provision created by a bank against standard assets was deductible under section 36(1)(viia).

Certain Benches had held that the provision was allowable since the provision had been created under the mandatory RBI guidelines and section 36(1)(viia) did not restrict the deduction only to non-performing assets.

Other Benches had taken the contrary view that standard assets were performing assets carrying no immediate recovery risk and therefore could not be regarded as bad or doubtful debts.

The controversy was accordingly referred to the Special Bench.

Facts of the Case

Malwa Gramin Bank was a regional rural bank and a scheduled bank covered by the Second Schedule to the Reserve Bank of India Act, 1934.

For AY 2012-13, which was taken as the representative year, the bank debited provisions and contingencies of ₹188.95 lakh to its profit and loss account. This included:

• provision for non-performing assets of ₹120 lakh; and
• provision for standard assets of ₹40 lakh.

Thus, the aggregate provision relating to advances was approximately ₹160 lakh.

The Assessing Officer accepted the provision created against NPAs but disallowed the provision of ₹40 lakh created against standard assets. According to the Assessing Officer, standard assets represented fully recoverable and income-generating advances. Therefore, no part of such assets could be considered bad or doubtful.

The CIT(A) confirmed the disallowance, observing that section 36(1)(viia) referred specifically to a provision for “bad and doubtful debts” and not to a general provision against performing standard assets.

Assessee’s Contentions

The assessee submitted that it was statutorily bound to classify its advances and create provisions in accordance with the RBI’s prudential norms.

The RBI guidelines required banks to create provisions not only against sub-standard, doubtful and loss assets but also against standard assets. Although standard assets were performing, they were not entirely free from credit risk. A small general provision was mandatory because a portion of such assets could become non-performing in future.

The bank further submitted that section 36(1)(viia) prescribed the maximum amount of deduction with reference to a percentage of total income and the aggregate average rural advances. It did not provide that the deduction would be confined to assets already classified as doubtful or non-performing.

In the representative year, the maximum permissible deduction was substantially higher than the provision actually made. Therefore, the entire book provision of approximately ₹160 lakh, including ₹40 lakh against standard assets, was claimed as deductible.

Findings of the Special Bench

The Special Bench examined the legislative history of section 36(1)(viia) and observed that the provision was introduced to permit banks to claim deduction for provisions against bad and doubtful debts even before the debts had actually become irrecoverable.

The provision was intended to promote rural lending and enable banks to maintain adequate buffers against the risks associated with their loan portfolios.

The Tribunal held that the principal requirements for claiming deduction were that:

• the eligible bank must create a provision for bad and doubtful debts in its books; and
• the deduction must remain within the overall statutory ceiling.

The Income-tax Act does not prescribe a separate methodology for identifying or computing the provision. Banks are, however, mandatorily governed by the RBI’s asset-classification and provisioning norms. Consequently, the RBI guidelines provide the relevant framework for quantifying the provision.

The Tribunal explained that standard assets, though performing, carry inherent credit, market and operational risks. They may subsequently become bad because of unforeseen circumstances. Provisioning against standard assets creates a buffer against potential losses and helps the bank maintain capital adequacy.

Further, an account may continue to be classified as a standard asset even where an amount is overdue, until the default crosses the regulatory threshold. Therefore, classification as a standard asset does not mean that the advance is entirely free from the possibility of default.

The Special Bench placed reliance on the Karnataka High Court’s decision in Bellad Bagewadi Urban Souhard Sahakari Bank Niyamit v. CIT, which recognised that banks were bound by RBI guidelines requiring general provision against standard assets.

It also referred to State Bank of Patiala v. CIT, where the Punjab and Haryana High Court held that creation of a provision in the books was necessary for claiming deduction under section 36(1)(viia). The decision supported the proposition that deduction was limited to the provision actually made in the books, subject to the statutory ceiling.

Accordingly, the Special Bench answered the reference in the affirmative and held that provision created against standard assets under the mandatory RBI norms qualifies for deduction under section 36(1)(viia).

The appeals were thereafter directed to be placed before the regular Division Bench for disposal in accordance with the Special Bench ruling.

Author’s Comments

Section 36(1)(viia) creates a deduction for a provision based on anticipated credit risk. It would defeat the preventive purpose of provisioning if the deduction were restricted only to loans that had already become impaired.

Nevertheless, the decision does not permit an unrestricted notional deduction. The bank must create an identifiable provision in its books, the provision should be in accordance with the applicable RBI norms, and the claim cannot exceed the statutory ceiling.

Banks should therefore maintain RBI circulars, asset-classification statements, computation of the book provision and a separate working of the ceiling under section 36(1)(viia). The deduction is governed by the lower of the qualifying provision actually created and the maximum amount permissible under the section.

Cases Discussed

• Nagpur Urban Cooperative Bank Ltd. v. ACIT, ITAT Jodhpur, 2013 (11) TMI 1696
• The Mayurbhanj Central Cooperative Bank Ltd. v. ACIT, ITAT Cuttack, 2012 (10) TMI 1176
• DCIT v. Gurdaspur Central Co-operative Bank Ltd., ITAT Amritsar, ITA No. 99/Asr/2011
• ACIT v. Hoshiarpur Central Co-op Bank Ltd., ITAT Amritsar, ITA No. 453/Asr/2015
• Vikramaditya Nagrik Sahkari Bank Maryadit v. ACIT, ITAT Indore, 2018 (3) TMI 1516
• Pali Central Co-Operative Bank Ltd. v. CIT, ITAT Jodhpur, 2017 (5) TMI 706
• DCIT, Vellore v. The Little Kancheepuram Co-operative Urban Bank Ltd., ITAT Chennai, 2013 (3) TMI 787
• Dy. CIT, Circle-IV, Jalandhar v. M/s Punjab Gramin Bank, Kapurthala, ITA No. 134(Asr)/2015
• DCIT v. Punjab Gramin Bank, ITA No. 731/Asr/2017
• ACIT v. M/s Chaitanya Godavari Grameen Bank, Guntur, ITA Nos. 326 & 327/Viz/2016
• The Baruch Dist. Central Co-op Bank Ltd. v. ITO, ITA No. 12521/Ahd/2012
• Andhra Bank, Hyderabad v. DCIT, ITA No. 1592/H/2008
• Bharat Overseas Bank Ltd., Chennai v. CIT-1, Chennai, ITA No. 1191/Mds/2012
• M/s Malwa Gramin Bank v. DCIT, ITA No. 134(Asr)/2015, order dated 22.06.2016
• M/s Malwa Gramin Bank v. DCIT, ITA No. 784/Asr/2017 & ors., order dated 05.04.2019
• Bellad Bagewadi Urban Souhard Sahakari Bank Niyamit v. CIT, Karnataka High Court
• Southern Technologies Ltd. v. JCIT, 320 ITR 577 (SC)
• New India Industries Ltd., 18 SOT 51 (Delhi) (SB)
• State Bank of Patiala v. CIT, 143 Taxman 196

FULL TEXT OF THE JUDGMENT/ORDER OF ITAT CHANDIGARH 

1. This Special Bench is constituted to decide the following question: –

“That the Ld. Appellate Authority has wrongly and illegally confirmed the disallowance claimed u/s 36(1)(viia) being the provisions of Bad & Doubtful Debts ignoring the pleadings, evidence and material on record and misconstrued the provisions as well as the statutory instructions of Reserve Bank of India being the Statutory Body of Banks?”

Brief Facts

2.1 The instant four appeals have been filed by the assessee against separate orders of learned first appellate authority for Assessment Years (AY) 2011-12, 2012-13, 2014-15 & 2015-16 dated 03-11-2016, 04-01-2017, 25-07-2018 & 16-01-2019 respectively. The erstwhile assessee ‘M/s Malwa Gramin Bank’ has now merged with M/s Punjab Gramin Bank and revised Form Nos.36, for all the years, reflecting such change has been placed on record. Admittedly, the facts and issues, on all vital points, are quite identical in all the four years. However, for the purpose of determination / facility of reference, the facts from case records of AY 2012-13 have been culled out in the order.

2.2 The case records of Assessment Year (AY) 2012-13 would reveal that the erstwhile assessee ‘The Malwa Gramin Bank’ is a regional rural bank and a scheduled bank being covered under Second Schedule to RBI Act, 1934. The assessee is stated to be engaged in banking business. The assessee filed its return of income on 19-09-2012 declaring income of Rs.14,30,49,669/- which was picked up for scrutiny assessment proceedings. The assessment was finalized u/s 143(3) on 17-03-2015 wherein the income of the assessee was computed at Rs.21,14,16,960/- after certain adjustments & disallowances. One of the issues as disputed by Ld. AO was assessee’s claim of deduction of provision of bad and doubtful debts (in short ‘PBDD) u/s 36(1)(viia) of the Income Tax Act, 1961. Feeling aggrieved, the assessee preferred further appeal before Ld. CIT(A) who concurred with the adjudication of Ld. AO on this issue vide impugned order dated 04-01-2017. Aggrieved, the assessee preferred further appeal before Tribunal.

2.3 During assessment proceedings, it transpired that the assessee debited provisions and contingencies in its Profit & Loss Account for Rs.188.95 Lacs as under: –

No.	Particulars	Amount (Rs.)
1	Amortization of Premium on investments	28.59 Lacs
2	Provisions for NPA	120.00 Lacs
3	Provisions for Standard Assets	40.00 Lacs
4	Provision for fraud by ex-employee	0.36 Lacs
Total		188.95 Lacs

The total provisions as made by the assessee towards non-performing assets (NPA) and Standard Assets (Items Nos.2 and Item Nos.3) thus aggregated to Rs.160 Lacs. These provisions were claimed by the assessee as deduction u/s 36(1)(viia). The Ld. AO accepted the provision made by the assessee against NPA but held an opinion that the provision made against ‘standard assets’ would not be allowable to the assessee on the ground that ‘standard assets’ represent loan facilities that were fully recoverable by the assessee. The assessee argued that it has made provisions for doubtful debts in terms of provisions of Sec.36(1)(viia) and the extent of deduction would be aggregate of 7.5% of total income (before making deduction under this clause and Chapter-VIA) + an amount not exceeding 10% of aggregate average advances made by its rural branches. In assessee’s case, the total income before deduction under Chapter-VIA was Rs.14.30 Crores. The 7.5% of the same would be Rs.107.28 Lacs and 10% of aggregate of average rural advances would be Rs.40.78 Crores. In other words, the assessee could make provision u/s 36(1)(viia) to the extent of Rs.41.85 Crores (Rs.1.07 Crores + Rs.40.78 Crores). As against this, the assessee made a provision of Rs.159.98 Lacs. Therefore, the aggregate provision of Rs.159.98 Lacs as made by the assessee would be fully allowable being well within the permissible limit as prescribed Sec.36(1)(viia).

2.4 The assessee fortified its claim by stating that it has made provisions against loans and advances as per binding prudential guidelines of Reserve Bank of India (RBI). The guidelines mandate creation of provisions even against ‘standard assets’ since in the banking industry, there would always be doubts that even some portion of ‘standard assets’ may go bad in future. It was further explained that the loans and advances as granted by the assessee to its customers would be categorized / classified as different assets as per RBI norms. The provision of doubtful debts would be made against differently classified assets as per RBI norms by applying prescribed percentage under each category of assets. The expression ‘doubtful’ has very wider meaning and the same represents the decision of the assessee-bank as to how doubtful debts are to be identified. Merely because the assets were classified as ‘standard assets’, the same would not mean that it could not be a doubtful asset from assessee’s point of view.

2.5 However, going by the provisions of Sec.36(1)(viia), Ld. AO opined that plain reading of the provision would indicate that the provisions made on account of bad and doubtful debts alone would be allowable and the provisions nowhere talks of the allowability of provisions made for the ‘standard assets’. The ‘standard assets’ are performing / income generating assets for the assessee-bank whereby the income is being earned and recognized in the books of accounts. Under these circumstances, nothing could be doubtful on the ‘standard assets’ as categorized by the bank. In such an eventuality, the assessee would not be entitled to lay claim on the impugned deduction to the extent of provision made against ‘standard assets’ for Rs.40 Lacs.

2.6 Upon further appeal, Ld. CIT(A) endorsed the view of Ld. AO as follows: –

6.3 I have considered the submissions made by the appellant and the argument given by the AO in the assessment order. Case laws relied upon by the Counsel of the appellant have also been perused, The crux of the arguments of the appellant is that the provision for bad and doubtful debts has been made as per strict guidelines of the RBI which is a statutory regulatory authority in its case. That Sec. 36(1)(viia) is a beneficial provision incentivizing the banks to provide rural finances calling for its liberal interpretation and that the deduction claim is within the limits prescribed in the said subsection. The same argument was raised before AO during assessment proceedings. It is seen that the AO has relied on the plain and unambiguous reading of the relevant provisions of the Act, which mentions the words “any provision for bad and doubtful debts”. The first proviso to clause (viia) of subsection 1 of Section 36 provides for “deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf,….”. Thus, it is quite clear that the provision on standard assets is not covered u/s 36(1)(viia) as these assets are regularly earning interest and are not in the nature of bad and doubtful assets. Case laws relied upon by the Counsel of the appellant are distinguishable on facts and hence not germane to the issue at hand. In view of the above, I’m of the considered view that the AO is justified in making the impugned disallowance. The same is, therefore, confirmed.

Aggrieved as aforesaid, the assessee challenged the findings of lower authorities before Tribunal.

2.7 When the appeal of the assessee came up before the Division Bench, the Division bench noted contrary decisions of the various benches of Tribunal and vide order dated 20-03-2020, has required the aforesaid issues to be placed before a Special Bench. Accordingly, this issue has come up for determination before this Special Bench.

Rival Submissions

3. We have heard Smt. Kusum Bansal, Ld. CIT-DR and Shri Rohit Kapoor and Shri Inderjeet Abhilashi, learned counsels for the assessee. With their able assistance, we have gone through the records and various contrary decisions of Tribunal. The clarifications were sought by the bench from time to time which was duly being addressed to by both the sides. Having heard rival submissions and upon perusal of case records, case laws as well as written submissions as filed by the respective parties, the question is determined as under.

Consideration

4. We have given our anxious consideration to the rival submissions made before us. It is undisputed fact that the assessee is eligible to lay claim on impugned deduction u/s 36(1)(viia) on account of provision made for bad and doubtful debts. The issue that falls for our consideration is to determine whether the assessee-bank would be entitled to lay claim deduction under Sec.36(1)(viia) of the Act towards provision made for ‘standard assets’ or not. The view taken in one sets of decisions, as referred to by co-ordinate bench, was that the assessee would be entitled for impugned deduction u/s 36(1)(viia) even for provisions made towards ‘standard assets’. These decisions are tabulated as under: –

1. Nagpur Urban Cooperative vs ACIT 2013 (11) TM 1696- ITAT, Jodhpur

2. Mayur Bhaj Central Co-operative Bank Ltd vs. ACIT, Balasore 2012 (10) TMI 1176 – Cuttack

3. DCIT us The Gurdaspur Central Coop Circle, Pathankot Bank Ltd in ITANO.99/Amritsar/2011 dated 7.5.2012

4. ACIT v Hoshiarpur Central Co-op Bank Ltd 2019 (1) TMI 96 ITAT

5. The Hoshiarpur Central Coop Bank Ltd, ITA / 47/ Amritsar/2011

6. Vikramaditya Nagrik Sahakari Bank 2018 (3) TMI 1516-ITAT Indore

7. Pali Central Co-operative Bank Ltd. 2017 (5) TMI 706-ITAT-Jodhpur

8. DCIT vs The Little Kancheepuram Cooperative Urban Bank Limited – ITA No. 23 & 24/2013 ITAT Chennai

However, a contrary view is said to be taken in the following decisions of the Tribunal: –

1. ACIT vs M/s Chaitanya Godavari Garameen Bank Guntur, ITA No. 326 & 327/Viz/2016 dated 4.5.2018 (ITAT Visakhapatanam)

2. The Baruch Dist. Central Co-op Bank Ltd vs ITO, ITA No. 12521/Ahd/2012 dated 26.7.2013(ITAT, Ahmedabad)

3. Andhra Bank, Hyderabad vs DCIT in ITA No. 1592/H/2008 dated 18.4.2013 of ITAT Hyderabad

4. Bharat Overseas Bank Ltd, Chennai vs CIT-1, Chennai in ITA No. 1191/Mds/2012 dated 28/8/2012 (ITAT, Hyderabad)

5. The Ld. AR, Shri Rohit Kapoor, has summarized the status of further appeals in above decisions before relevant High Courts as under:

Name of the case	Relevant High Court	Status of appeal
M/s Nagaur Urban Co-operative Bank Limited, Circle-Nagaur Versus Asstt CIT, ITAT JODHPUR 2013 (11) TMI 1696	Rajasthan	No appeal has been filed
The Mayurbhanj Central Cooperative Bank Ltd. Versus ACIT Balasore Circle, ITAT CUTTACK-2012 (10) TMI 1176	Orissa	No appeal has been filed
DCIT, Pathankot V Gurdaspur Central Co-op. Bank Ltd. ITAT AMRITSAR- ITA NO. 99 (ASR) OF 2011,2012 (10) TMI 204	Punjab & Haryana	No appeal has been filed
ACIT Versus The Hoshiarpur Central Co op. Bank Ltd. ITAT AMRITSAR 2019 (1) TMI 96 – ITA NO. 453/ASR/2015	Punjab & Haryana	No appeal has been filed
Vikramaditya Nagrik Sahkari Bank Maryadit Versus ACIT Ujjain-ITAT INDORE 2018 (3) TMI 1516	Madhya Pradesh	No appeal has been filed
Pali Central Co-Operative Bank Ltd. Versus CIT- ITAT JODHPUR, 2017 (5) TMI 706	Rajasthan	No appeal has been filed
M/s Nagaur Urban Co-operative Bank Limited, Circle-Nagaur Versus Asstt. CIT, ITAT JODHPUR 2013 (11) TMI 1696	Rajasthan	No appeal has been filed
DCIT, Vellore Versus The Little Kancheepuram Co-operative Urban Bank Ltd ITAT CHENNAI 2013 (3) TMI 787	Madras	No appeal has been filed
Dy. CIT, Circle-IV, Jalandhar Vs. M/s Punjab Gramin Bank, Kapurthala in ITA No. 134(Asr)/2015; dated 22.06 ITA No. 134(Asr)/2015	Punjab & Haryana	No appeal has been filed
DCIT vs. Punjab Gramin Bank (ITA No.731/Asr/2017) (ITA No.731/Asr/2017)	Punjab & Haryana	No appeal has been filed

It has further been stated that in the case of Andhra Bank (supra) (as per Serial No.3 of reference for Constitution of Special bench dated 27-01-2020), where the decision was adverse to the assessee, the concerned bank has filed an appeal before the Hon’ble High Court of Telangana which is still pending for adjudication. It has further been stated that no other case on this issue is presently pending before any High Court. The attention of the bench has also been drawn to the fact that in assessee’s own case for AY 2008-09, this issue was decided by Amritsar Tribunal (ITA No.134/Asr/2015 dated 22-06-2016) in assessee’s favor by holding that the deduction was to be allowed to the assessee in respect of PBDD. The provisions of Sec. 36(1)(viia) do not differentiate between provision on bad assets and provisions on standard assets. This deduction was allowed only in respect of certain categories of the assessee. The deduction was neither limited to quantum of bad debts in books nor with reference to quantum of standard assets but with reference to total income of the specified banks and also based upon quantum of average advances. The deduction was for anticipated defaults on loans and advances made in respect of total assets including standard assets. Following this decision, similar view was expressed by co-ordinate bench in AY 2014-15 (ITA No.784/Asr/2017 & ors.; dated 05-04-2019). The Ld. AR pointed out that though the tax effect in these years exceeded monetary limit prescribed by CBDT for departmental appeal, however, the department did not prefer further appeal on this issue before Hon’ble High Court. This issue, thus, attained finality in assessee’s favor, in both these years.

6. The Ld. AR further stated that the definition of “advances” for the purpose of banking regulations as well as for Section 36(1)(viia) includes Standard Assets, Sub-Standard Assets, Doubtful Assets and Loss Assets. The provisions of Section 36(1)(viia) explicitly provide that a scheduled bank is entitled to deduction for provision for bad and doubtful debts, subject to the prescribed ceiling of 7.5% of the total income and 10% of the aggregate advances made by rural branches. The statute uses the expression “aggregate advances made by rural branches” without carving out any distinction between standard, sub-standard, doubtful or loss assets and the legislatures did not contemplate any segregation or restricted interpretation. The deduction u/s 36(1)(viia) is neither limited to the quantum of provisions made in the books of account, nor restricted to the amount of standard assets. The provision is allowable based on anticipated credit losses in respect of all advances including standard assets. The Ld. AR further argued that the RBI Circular No. 258 dated 14-06-1979, explaining the intent behind the introduction of Section 36(1)(viia), unequivocally states that the deduction was introduced to promote rural banking and that provision was required to be made on aggregate rural advances. In fact, Hon’ble Karnataka High Court in the case of Bellad Bagewadi Urban Souhard Sahakari Bank Niyamit v. CIT (2018 (3) TMI) restored the matter to the Tribunal while observing that the assessee was bound to follow RBI guidelines. While doing so, the Hon’ble Court observed that any contrary view taken by the Income Tax Authorities would disentitle the assessee from claiming deduction u/s 36(1)(viia) of the Act which was not justified. With these observations, the matter was remanded back to Tribunal with a direction to the assessee to support its claim with relevant documents. Finally, as per RBI Circular dated 01-07-2010, Non-Performing Assets (NPAs) – which include Sub-standard, Doubtful and Loss Assets – are defined as accounts where instalments are overdue for more than 90 days. Therefore, any account with delays up-to 90 days continues to be classified as a ‘standard assets’ despite inherent credit risk. This confirms that ‘standard assets’ also carry inherent risk, necessitating prudential provisioning. Additionally, even NPAs purchased from another bank are initially categorized as ‘standard assets’ notwithstanding the embedded recovery risks. This categorization underscores that ‘standard assets’ are not free from credit risk and therefore, provisioning on ‘standard assets’ is consistent with banking prudential norms. The Ld. AR bolstered this argument by adding that even the classification of standard asset is not uniform. As per agricultural lending norms as prescribed by RBI, classification of agricultural loans as NPA is based on crop cycle instead of the 90-day overdue norm. For short duration crop loans (crop cycle up-to one year such as paddy and wheat), a loan is treated as NPA only if it remains overdue for more than two crop seasons. For long duration crops (crops cycle exceeding one year), it becomes NPA if overdue is for more than one crop season. In such cases, the classification of standard asset would not be uniform even as per RBI guidelines. By way of these arguments, Ld. AR supported the case of the assessee. The Ld. CIT-DR, on the other hand, referred to the statutory provisions of Sec. 36(1)(viia) along with the decision of Hon’ble Apex Court in the case of Southern Technologies Ltd. (187 Taxman 346) to support the case of the revenue.

7. Upon careful consideration of facts on records, it emerges that the assessee is a regional rural bank and it is a scheduled bank being listed in Second Schedule of The Reserve Bank of India (RBI) Act, 1934. The bench finds that the provisions of Sec. 36(1)(viia) enable a deduction to the banks and financial institutions for provisions made by them towards bad and doubtful debts (in short ‘PBDD’). The same is with a view to support the stability of the banking system particularly in dealing with non-performing assets (NPAs). The intent of these provisions could be ascertained by tracing the legislative history of the aforesaid provisions. It could be seen that the provisions of Sec.36(1)(viia) were introduced by The Finance Act, 1979 and the provisions initially provided for a deduction in respect of any provisions made by eligible assessee-bank towards bad and doubtful debts in relation to advances made by its rural branches subject to the maximum limit of one and half percent of the aggregate average advances made by such branches, computed in the prescribed manner. The rational to introduce the same (as contained in Memorandum explaining the provisions in the Finance Bill, 1979) was to encourage commercial banks particularly public sector banks to reach out in rural areas and to expand the rural credit. In order to promote rural banking and assist the scheduled commercial banks in making adequate provisions from their current income to provide for risks in relation to the rural advances, these new provisions were inserted in the Act. The proposed deduction was to be limited to 1 ½ percent of the aggregate average advances made by rural branches as defined. This deduction was available from AY 1980-81 onwards. Thus, the whole objective was to encourage commercial banks, especially public sector banks, to expand rural credit and make adequate provisions for risks associated with rural advances.

8. These provisions came to be amended from time to time and at present, the provisions read as under: –

(viia) in respect of any provision for bad and doubtful debts made by—

(a) a scheduled bank [not being a bank incorporated by or under the laws of a country outside India] or a non-scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank, an amount not exceeding eight and one-half per cent of the total income (computed before making any deduction under this clause and Chapter VIA) and an amount not exceeding ten per cent of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner :

Provided that a scheduled bank or a non-scheduled bank referred to in this sub-clause shall, at its option, be allowed in any of the relevant assessment years, deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, for an amount not exceeding five per cent of the amount of such assets shown in the books of account of the bank on the last day of the previous year:

Provided further that for the relevant assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, the provisions of the first proviso shall have effect as if for the words “five per cent”, the words “ten per cent” had been substituted:

Provided also that a scheduled bank or a non-scheduled bank referred to in this sub-clause shall, at its option, be allowed a further deduction in excess of the limits specified in the foregoing provisions, for an amount not exceeding the income derived from redemption of securities in accordance with a scheme framed by the Central Government:

Provided also that no deduction shall be allowed under the third proviso unless such income has been disclosed in the return of income under the head “Profits and gains of business or profession.”

Explanation. —For the purposes of this sub-clause, “relevant assessment years” means the five consecutive assessment years commencing on or after the 1st day of April, 2000 and ending before the 1st day of April, 2005;

(b) a bank, being a bank incorporated by or under the laws of a country outside India, an amount not exceeding five per cent of the total income (computed before making any deduction under this clause and Chapter VI-A);

(c) a public financial institution or a State financial corporation or a State industrial investment corporation, an amount not exceeding five per cent of the total income (computed before making any deduction under this clause and Chapter VI-A) :

Provided that a public financial institution or a State financial corporation or a State industrial investment corporation referred to in this sub-clause shall, at its option, be allowed in any of the two consecutive assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, of an amount not exceeding ten per cent of the amount of such assets shown in the books of account of such institution or corporation, as the case may be, on the last day of the previous year;

(d) a non-banking financial company, an amount not exceeding five per cent of the total income (computed before making any deduction under this clause and Chapter VI-A).

Explanation. —For the purposes of this clause, —

(i) “non-scheduled bank” means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank;

(ia) “rural branch” means a branch of a scheduled bank or a non-scheduled bank situated in a place which has a population of not more than ten thousand according to the last preceding census of which the relevant figures have been published before the first day of the previous year;

(ii) “scheduled bank” means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959*), a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any other bank being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934);

(iii) “public financial institution” shall have the meaning assigned to it in section 4A79 of the Companies Act, 1956 (1 of 1956);

(iv) “State financial corporation” means a financial corporation established under section 3 or section 3A or an institution notified under section 46 of the State Financial Corporations Act, 1951 (63 of 1951);

(v) “State industrial investment corporation” means a Government company within the meaning of section 61780 of the Companies Act, 1956 (38 of 1956), engaged in the business of providing long-term finance for industrial projects and eligible for deduction under clause (viii) of this sub-section;

(vi) “co-operative bank”, “primary agricultural credit society” and “primary co-operative agricultural and rural development bank” shall have the meanings respectively assigned to them in the Explanation to sub-section (4) of section 80P;

(vii) “non-banking financial company” shall have the meaning assigned to it in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934);

A bare reading of these provisions would show that an eligible assessee is entitled for such deduction of PBDD subject to maximum ceiling of 8 ½% (at present) of the total income (computed before making any deduction under this clause and Chapter VIA) and an amount not exceeding 10% (at present) of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner. This new methodology of computation was brought into effect by Finance Act, 1986. The effect of amendment, as explained in CBDT Circular No.464 dated 18-07-1986, was under: –

Modification in respect of deduction on provision for bad and doubtful debts made by the banks.

5.1 Under the existing provisions of clause (viia) of sub-section (1) of section 36 of the Income-tax Act inserted by the Finance Act, 1979, provision for bad and doubtful debts made by scheduled or a non-scheduled Indian bank is allowed as deduction within the prescribed limits. The limit prescribed is 10 per cent of the total income or 2 per cent of the aggregate average advances made by the rural branches of such banks, whichever is higher. It had been represented to the Government that the foreign banks were not entitled to any deduction under this provision and to that extent, they were being discriminated against. Further, it was felt that the existing ceiling in this regard, i.e., 10 per cent of the total income or 2 per cent of the aggregate average advances made by the rural branches of Indian banks, whichever is higher, should be modified. Accordingly, by the Amending Act, the deduction presently available under clause (viia) of sub-section (1) of section 36 of the Income-tax Act has been split into two separate provisions. One of these limits the deduction to an amount not exceeding 2 per cent of the aggregate average advances made to by rural branches of the banks concerned. It may be clarified that foreign banks do not have rural branches and hence this amendment will not be relevant in the case of the foreign banks. The other provisions secure that a further deduction shall be allowed in respect of the provision for bad and doubtful debts made by all banks, not just the banks incorporated in India, limited to 5 per cent of the total income (computed before making any deduction under this clause and Chapter VIA). This will imply that all scheduled or non-scheduled banks having rural branches would be allowed the deduction up to 2 per cent of the aggregate average advances made by such branches and a further deduction up to 5 per cent of their total income in respect of provision for bad and doubtful debts.

By way of this amendment, all scheduled or non-scheduled banks having rural branches were to be allowed deduction up to 2 per cent of the aggregate average advances made by such branches and a further deduction up to 5 per cent of their total income in respect of provision for bad and doubtful debts. These percentages of 2% & 5% have since been enhanced to 10% & 8 ½%. The rationale of substitution was to give two separate deductions, viz., one in respect of rural advances and the other for provision for bad and doubtful debts in general and also to extend the benefit of deduction to all banks including foreign banks.

9. It could thus be inferred that the provisions of Sec.36(1)(viia) were introduced by Finance Act, 1979 w.e.f. 01st April, 1980 with an objective to allow the banks to claim deduction for provisions made towards bad and doubtful debts even if the debts had not actually become irrecoverable. The reasoning was that the banks were required to follow Reserve Bank of India (RBI) guidelines for provisioning. However, in terms of Sec.36(1)(vii), only actual bad debts could be deducted by the assessee in computing its income. This mismatch led to denial of deductions of PBDD. Accordingly, these provisions were introduced and after various amendments to Sec.36(1)(viia), the scheduled banks (not being foreign banks) and cooperative banks (excluding primary agricultural credit societies or primary co-operative agricultural and rural development banks) were allowed deduction subject to overall ceiling of 8.5% of total income (before deductions under Chapter VI-A and this section) and 10% of aggregate average advances made by rural branches of the bank. The provisions of Sec. 36(1)(viia) thus supports banks in maintaining prudential provisioning norms and provide a tax incentive for provisioning which is essential in managing credit risk. It also helps bank align the financial reporting with RBI regulations without adverse tax consequences. The first proviso to Sec. 36(1)(viia) provide an option to the assessee to claim deduction in respect of any provisions made by it for any assets classified by the RBI as doubtful assets or loss assets in accordance with RBI guidelines subject to the condition that such deduction would not exceed 5% of amount of such assets as shown in the books of account of the bank on the last day of the previous year. However, Explanation to this sub-clause provide that “relevant assessment years” mean five consecutive years commencing on or after 01-04-2000 and ending before 01-04-2005. This option, thus, was available for specified limited duration only and is not relevant for present assessment years before us.

10. A bare reading of the statutory provisions of Sec.36(1)(viia) would further reveal that the only requirement to claim the said deduction is that a provisions for bad and doubtful debts should be made by the eligible assessee in its books of account. There is no other requirement except for overall ceiling on such deduction. Moreover, there is no rule under Income Tax Act which specifies methodology for computation of aforesaid provisions. Nevertheless, the assessee is bound to follow RBI guidelines on provisioning norms and it has no other option to quantify the same in any other manner. The RBI guidelines mandate the assessee to make general provisions even against ‘standard assets’. The same is on the logic that these assets, though performing assets, always carry some inherent business risk and may go bad in future. Under this situation, the assessee is obligated to make the provisions as per specified percentages of ‘Standard Assets’ as well as against NPAs also. The only other condition of Sec. 36(1)(viia) is that the overall provision, in no case, would exceed 8 ½% of the total income (computed before making any deduction under this clause and Chapter VIA) and an amount not exceeding 10% of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner. Undisputedly, the assessee has fulfilled both the conditions i.e., it has made provision for Bad and Doubtful debts in its books of accounts and it has also not violated the overall ceiling of claiming such deduction. The provision has been made as per mandatory guidelines of RBI which mandate creation of general provisions against ‘standard assets’ also.

11. To elucidate further, the assessee is mandated to follow RBI guidelines for income recognition, asset classification and provisioning norms on its loans and advances portfolio. The main sponsor of the assessee bank is State Bank of Patiala. In terms of SBOP Circular No. GMO/REC/ADV/2 of 2005-06 dated 20-04-2006 relating to provisioning requirements pertaining to advances, the assessee is required to classify its loan & advances into ‘Standard Assets’ and non-performing assets (NPA). The ‘standard assets’ are performing assets for the bank. The remaining loans, on the other hand, are considered as non-performing assets (in short ‘NPA’), The NPAs are further classified into sub-standard assets, doubtful assets and loss assets. ‘Standard Assets’ are those assets which do not disclose any problem and the recovery of the same do not carry more than normal risk attached to assessee’s business. The NPAs carry more than normal business risk for the assessee and accordingly, require adequate provisions against them. The sub-standard assets are those assets which have remained NPA for a period of less than 12 months. The doubtful assets are those assets which have remained NPA for a period of more than 12 months whereas loss assets are those assets which have been identified to be not recoverable at all. Against NPAs, the assessee is required to maintain provisions at specified percentages. The same ranges between 10% to 20% for sub-standard assets whereas the same ranges from 25% to 100% for doubtful Assets. The loss assets require 100% provisioning.

As per the Circular, the assessee is further required to maintain general provision of 0.25% to 0.40% against ‘standard assets’ also depending on the category of loan facility. There is no dispute to the extent of provisions created by the assessee on NPAs since the same are clearly in the nature of provision for bad and doubtful debts. In fact, the provision, to that extent, has already been allowed by Ld. AO. The dispute has arisen only on account of provision made for ‘standard assets’. The contention of the revenue is that standard assets are performing assets for the bank which do not pose any difficulty of recovery and therefore, no provision is required against them. The assessee, on the other hand, contends that though these are performing assets, still they pose a risk of recovery and may go bad subsequently. Further, the provision against ‘standard assets’ is to be made as mandated by the prudential norms issued by the RBI and therefore, the same is covered by eligible deduction u/s 36(1)(viia) subject to the maximum limits as laid down there-under i.e., 8.5% of total income (before deductions under Chapter VI-A and this section) and 10% of aggregate average advances made by rural branches of the bank.

12. In the light of RBI guidelines on provisioning, it could be said that provision for ‘standard assets’ (though they are performing assets for the bank) would still be required since even ‘standard assets’ carry some level of inherent risk such as credit risk, market risk, or operational risk and they may subsequently go bad. The provisioning against ‘standard assets’ helps banks absorb potential losses that may arise from ‘standard assets’ due to unforeseen circumstances. The provisioning on ‘standard assets’ demonstrates prudence and caution in financial reporting, acknowledging that even performing assets may pose some risk. The RBI guidelines on provisioning on ‘standard assets’ is to ensure that banks maintain a buffer against even probable potential losses. The same would help the bank to further mitigate potential losses and enable the bank to maintain capital adequacy. The objective of RBI guidelines is to ensure that provisions for all losses that may even be remote, is still made by the banks so as to ensure that sufficient capital adequacy is maintained by the bank. The expression used is ‘provision for bad and doubtful debts’ and the prudential norms of RBI require the assessee to mitigate potential losses though the same may be remote one and may arise on ‘standard assets’ also. The said observation is fortified by the fact that an account continues to be classified as ‘standard asset’ even if the amount is overdue until such overdue exceeds 90 days. Even this period is not uniform for crop loans. The classification as standard asset merely indicates that either the advances are regular or the period of default has not yet crossed the regulatory threshold period as prescribed by RBI. Therefore, all the ‘standard assets’ are not inherently completely free from credit risk and always bear risk of going bad in future which necessitate provisioning against these assets also to safeguard the bank from potential losses. Recognizing the inherent and continuing credit risk, RBI mandate banks to create provision on ‘standard assets’ at prescribed rates ranging from 0.25% to 1% depending upon the nature of advances. These provisions are intended to cover the inherent risk of default and anticipated loss as even performing assets may exhibit early signs of stress. Thus, ‘standard assets’, though currently preforming, are not free from credit risk and the banks are required to acknowledge and provide for this risk through mandatory provisioning.

13. At this juncture, it would be pertinent to note the decision of Hon’ble Karnataka High Court in the case of Bellad Bagewadi Urban Souhard Sahakari Bank Niramit vs. CIT (supra) (as quoted by Ld. AR) which is squarely applicable to the impugned issue before us. The Hon’ble Court, after considering rival submissions, adjudicated the issue as under: –

5. We have heard the learned counsel appearing for the parties and perused the material on record.

6. It is apparent from the material placed before us that the RBI guidelines prescribes the provision on standard assets from the year ended March 31, 2000 directing the banks to make a general provision of a minimum of 0.25% on standard assets.

7. In our opinion, the decision rendered by the Commissioner of Income Tax is unjustifiable for the reason that assessee is bound by the guidelines issued by the Reserve Bank of India. Any contrary view taken by the Income Tax Authorities would disentitle the assessee from claiming deduction under Section 36(1)(viia) of the Act. In view of non-furnishing of the material documents in support of the claim before the Tribunal, it was left with no other option except to confirm the order of the Commissioner of Income Tax (Appeals).

8. Having regard to the nature and circumstances, we deem it appropriate to remand the matter to the Tribunal setting aside the impugned order with liberty to the assessee to place on record the material documents in support of its case for deduction towards provision for bad debts made for standard assets of Rs.15,00,000/- relating to the assessment year 2011-12.

9. Accordingly, the appeal is allowed. The impugned order is set-aside and the matter is remanded to the Tribunal for fresh consideration. All rights and contentions of the parties are kept open. The Tribunal shall pass appropriate orders after providing an opportunity of hearing to the assessee in accordance with law as expeditiously as possible.

The Hon’ble Court observed that the assessee was bound by the guidelines issue by RBI and any contrary view as taken by lower authorities would disentitle the assessee to claim the said deduction which was unjustified. This case law clearly supports the case of the assessee.

The decision of Southern Technologies Ltd. (supra), as referred to by Ld. CIT-DR is in the context of claim of deduction u/s 36(1)(vii) by NBFC and the same does not address the controversy before us.

The decision in New India Industries Ltd. [18 SOT 51 (Delhi) (SB)], as quoted before us, is also in the context of deduction u/s 36(1)(vii) for NBFC. The same, therefore, is not of much relevance.

Another decision quote before us is the decision of Hon’ble High Court of Punjab & Haryana in State Bank of Patiala vs. CIT (143 Taxman 196). In this decision, the assessee claimed higher deduction u/s 36(1)(viia) in its computation of income but made a lessor provision in the books of accounts. The Hon’ble Court held that making of provision in the books of accounts was necessary for claiming deduction u/s 36(1)(viia) and therefore, the deduction was allowed up-to the provisions made by the assessee in its books of accounts. This decision supports our view that whatever provision has been made pursuant to RBI guidelines is to be allowed as deduction u/s 36(1)(viia) subject to overall ceiling as prescribed therein.

14. We note that at present there is no decision of the jurisdictional High Court which has been brought to our notice on the issue. We further note that the issue is pending before the Telangana High Court in the case of Andhra Bank (supra), at the instance of the assessee. Considering the overall circumstances and particularly in view of the decision of the Karnataka High Court in Bellad Bagewadi Urban Souhard Sahakari Bank Niramit vs. CIT (supra), we are inclined to answer the reference in affirmative.

15. The appeals shall now be placed before the regular Division Bench for disposal according to law.

Order pronounced in the open court on 05-05-2026