T. C. A. Ramanujam

We need a law that deals adequately with the contingency of financial institutions falling sick because of non-performing assets.

High volume of irrecoverable debts plague both banking and non-banking financial institutions. The Income-Tax Act grants deduction from profits towards irrecoverable debts. The law originally insisted that to secure deduction, the debt should be established to have become bad.

With effect from the assessment year 1989-90 the law was amended, laying down that a company need only to show that the bad debt has been written off as irrecoverable. The write-off should, however, be bona fide. The law also says that a provision for bad and doubtful debts may be allowed as a deduction in computing profits to the extent of 7 ½ per cent of the total income and an amount not exceeding 10 per cent of the aggregate average advances by rural branches of the bank.

T. N. Power Finance & Infrastructure Development Corporation Ltd is a public financial institution satisfying the definition of infrastructure development finance company. The company was supposedly eligible to claim deduction under Section 36 (i)(viia)(c) of the I-T Act from AY 1992-93 onwards. In AY 1998-99, the company had made a provision for non-performing assets and this was debited to the profit and loss (P&L) account. It had declared a total income of Rs 5.16 crore.

The provision was disallowed by the AO under Section 36 (1)(vii) on the ground that a mere provision debited to the P&L cannot be allowed as a deduction unless it is an ascertained liability. What the company claimed was only a contingent liability. The lower authorities confirmed such disallowance and the matter went to the Madras High Court ((T. N. Power Finance & Infrastructure Development Corporation Ltd — 288 ITR 491).

It was argued for the company that the debts were incurred in the course of business and the purpose for which the finance was used by the other parties was not relevant for allowing the deduction of debts written off. The claim was limited to Section 36 (1)(vii).

The ruling

The Madras High Court dismissed the company's appeal. It was not convinced by the argument that the provision was made as per the directions of the RBI. The court referred to Section 36(1)(viia) and pointed out that deduction was allowed towards provision to a maximum extent of 5 per cent of the total income only and the provision should be for debts which are predominantly revenue in nature or trade related and not for provision for non-performing assets which are predominantly capital in nature. The Corporation had claimed a provision of Rs 30 lakh towards non-performing assets. As the Department found that the non-performing assets related to capital goods and assets, the court agreed that disallowance was rightly made. Financial re-construction needs stimulus.

The present provision in the law, either under Section 36 (1)(vii) or Section 36 (1)(viia), is found inadequate to deal with the contingency of financial institutions falling sick because of non-performing assets. Takeovers and mergers are sympathetically viewed in the case of manufacturing concerns.

Amounts taken to interest suspense account without writing off in the accounts are allowed as a deduction. Sections 36(1)(vii) and (viia) contain difficult conditions and not many institutions will be able to take advantage of them. One hopes that the Budget provides relief by way of a liberal amendment to these Sections.

(The author is a former Chief Commissioner of Income-Tax.)

© Copyright 2000 - 2009 The Hindu Business Line