Lenders to have final say in NPA classification: HC

In what would provide a major relief to banks who are plagued with fears of rising defaults and bad debt, the Bombay High Court has ruled that the decision of a bank in assessing a debt as bad is the final word for writing it off and claiming deduction on income tax (I-T).

The high court delivered the judgement after hearing an appeal filed by the I-T department against deductions claimed by Oman International Bank. The court ruled in favour of the bank stating that the classification of bad debt is a commercial decision of the assessee (bank in this case) and once an entry is made in its accounts, it would be established as bad debt. The judgement was delivered in February this year.

There will be no further burden or obligation on the part of the assessee to prove a written-off debt as bad debt and hence the assessee can claim deduction against it for the year in which the amount of debt is written off, the court said. The onus is on the department to show that the debt is not bad if it is not satisfied with the reasoning of the assessee. In 2007, the I-T department lost the same case against the Oman International Bank, after the Appellate Authority in Mumbai ruled in the bank’s favour.

According to an amendment in Section 36, such deduction is now available under Section 36 (1) (vii). The court is of the view that the law is very clear on the classification of bad debt and it states that a mere provision for bad and doubtful debt cannot be written off for claiming deduction. In fact, the debt has to be irrecoverable for being written off to be eligible for deduction. In fact, the amendment was incorporated to avoid such litigations. Prior to the amendment, the assessing officer has to be convinced about the quality of debt to allow deductions.

The court order has defined a debt as bad if there are no reasonable expectations of recovery of dues from that account. Tax officials are of the view that the companies are using this to evade tax. Healthy business groups park their surplus funds with their financially weak companies as loans. Since these weak companies do not pay interest on these loans, the loan gets written off and the principal and interest are claimed as deduction.

Banks, on their part, will have to make full provisioning for bad debt (set aside funds equivalent of the full amount of the loan), according to an RBI guideline.

However, there are tax benefits for provisioning. Since write-offs are allowed for deduction from tax claims, most banks are writing off bad debt rather than making provisions. Banking sources say the recovery is hampered once the loan is written off and thus it is compensated at least with deduction claimed from the income tax.