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A. Facts of the Case
1. The querist has quoted the following paragraphs from Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’:
“5. Taxable income is calculated in accordance with tax laws. In some circumstances, the requirements of these laws to compute taxable income differ from the accounting policies applied to determine accounting income. The effect of this difference is that the taxable income and accounting income may not be the same.
6. The differences between taxable income and accounting income can be classified into permanent differences and timing differences. Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference.
7. Timing differences are those differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income. For example, machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machinery for accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed will differ. Another example of timing difference is a situation where, for the purpose of computing taxable income, tax laws allow depreciation on the basis of the written down value method, whereas for accounting purposes, straight line method is used. …”
2. According to the querist, although the principles laid down in AS 22 are spelt out, the application of these principles in practice has posed certain issues for banks. It is observed that in banking companies, there have been large variations in the application of AS 22. The querist has observed that the treatment for deferred tax calculation differs particularly in deferred tax on investments classified as Held to Maturity and deferred tax on provision for bad and doubtful debts.
Deferred tax on Investments (Held to Maturity)
3. The querist has stated that as per RBI Regulations, all the banks are allowed to maintain 25% of its total investment as “Held to Maturity” and the quantum of 25% should not be more than the DTL (Demand and Time Liability).
4. The treatment of investments in the books of account of a banking company is primarily governed by the RBI Guidelines. The querist has summarised the RBI guidelines for long term investments (Held to Maturity) as follows:
Investments classified under the held to maturity category need not be marked to market. They should be carried at acquisition cost, unless it is more than face value, in which case the premium is amortised over the unexpired period till maturity. Diminution in value of investments under ‘held to maturity category’ is to be provided only if such diminution is other than temporary in nature.
5. The querist has stated that tax considerations for depreciation on investments were initially governed by the CBDT Circular No. 665 dated 5th October, 1993. In the said circular, it was stated that “…the Assessing Officers should determine on the facts and circumstances of each case as to whether any particular security constitutes stock-in-trade or investment taking into account the guidelines issued by the Reserve Bank of India in this regard from time to time”. Therefore, Assessing Officers had the power to segregate the securities into investments and stock in trade based on the guidelines issued by the RBI. Consequently, the banks did not have an option to take the mark to market benefit on investments held under the Held to Maturity (HTM) category.
6. However, as per the querist, the guidelines and clarifications issued by the above circular seem to have been diluted by the Supreme Court decision in United Commercial Bank vs. Commissioner of Income Tax (1999) 240 ITR 355 (SC). In the said decision, the Supreme Court has held that “Preparation of the balance-sheet in accordance with the statutory provision would not disentitle the assessee in submitting the income-tax return on the real taxable income in accordance with a method of accounting adopted by the assessee consistently and regularly. That cannot be discarded by the departmental authorities on the ground that the assessee was maintaining the balance-sheet in the statutory form on the basis of the cost of the investments. In such cases, there is no question of following two different methods for valuing its stock-in-trade (investments) because the bank was required to prepare the balance-sheet in the prescribed form and it had no option to change it. For the purpose of income-tax as stated earlier, what is to be taxed is the real income which is to be deduced on the basis of the accounting system regularly maintained by the assessee and that was done by the assessee in the present case.”
7. Therefore, as per the querist, based on the rationale laid down by the Supreme Court, if a bank is consistently valuing its stock in trade (investments) at lower of the cost and market price, then it would be entitled to claim the same as deduction, notwithstanding the fact that the same is shown at cost in the balance sheet as per statutory requirements.
8. According to the querist, the difference in the treatment of HTM securities as per books of account and for tax purposes results in a difference between book profits and tax profits till the securities are disposed off. At the time of disposal of such securities, the profit/loss on disposal as recorded in the books of account as well as that offered for tax will be equal to the difference between the cost of acquisition and the sale value of the investment. Therefore, the differences as indicated above will automatically reverse at the time of disposal of the securities. According to the querist, as per AS 22, such a difference will be classified as a timing difference and, thus, will require creation of a deferred tax asset/liability.
Deferred tax on Provision for bad and doubtful debts
9. The querist has further stated that the creation of provision for bad debts in the books of account of banking companies is governed by the Reserve Bank of India Regulations. As per the relevant RBI Regulations, banking companies have to appropriately classify their advances into four categories as under:
1. Standard Assets
2. Sub-Standard Assets
3. Doubtful Assets
4. Loss Assets
10. Based on the above grouping, RBI has prescribed the rates at which the provision has to be created in the books of banks. This ranges from 10% to 100% (for item 2, 3 and 4) depending upon the various conditions laid down for the advance. These provisions are known as Provision for Non-Performing Assets (NPA). Even for debts which are considered to be not recoverable, a 100% provision is created in the books of account before writing them off as bad. A small percentage provision is also created for all the Standard Assets as per the norms of the RBI.
11. The querist has stated that section 36(1)(viia) of the Income-tax Act, 1961 lays down limits to the extent of which provision for doubtful debts will be allowed as a deduction. Any other bad debts (other than the provision for the year) are allowed as a deduction under section 36 (1)(vii) to a banking company only if the total amount of bad debts written off exceeds the total amount of provision already allowed as a deduction under section 36 (1)(viia).
12. Owing to the above accounting treatment of Provision for Non Performing Advances, there exists a difference in the income as per records maintained for income-tax purposes and income as per the books of account. According to the querist, this is a timing difference that will match in future by way of either recovery or write-off.
B. Query
13. The querist has sought opinion of the Expert Advisory Committee on the following issues:
(i) Whether the difference between the value of investment as per the books of account and as per the records created for income tax purposes, which will get cleared when the relevant security is disposed off by the bank, in respect of Held to Maturity investments should be considered for the purpose of deferred tax asset/ liability as per the provisions of timing difference in accordance with AS 22.
(ii) Whether the difference in the provision for bad debts (provision for Non Performing Assets) as per the books of account and as per income-tax is a timing difference and therefore, whether it requires creation of deferred tax asset/liability in accordance with AS 22.
C. Points considered by the Committee
14. The Committee notes that the basic issues raised by the querist are related to deferred tax implications of difference in value of HTM investments for accounting and tax purposes and difference in provision for bad and doubtful debts for accounting and tax purposes, in the situations as specified in the facts of the case. Therefore, the Committee has examined only these issues and has not examined any other issue that may arise from the Facts of the Case, such as, appropriateness of treatment of HTM investments as stock-in-trade for tax purposes. Further, the Committee refrains from expressing any view on the correctness of interpretation of tax treatment by the querist, including present status of CBDT Circular No. 665 dated 5th October, 1993.
15. As per the querist, there is difference between taxable income and accounting income due to difference in valuation of HTM investments for tax purposes and accounting purposes. If such differential valuation is accepted by the Income-tax department, a question arises as to whether the difference is a timing difference or a permanent difference.
16. The Committee notes paragraphs 5, 6 and 7 of AS 22 quoted by the querist in paragraph 1 above. Further, the Committee notes the following definitions given in AS 22:
“4.6 Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.
4.7 Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.”
17. From the above, the Committee is of the view that there are two essentialities for timing differences to arise:
(i) There should be difference between taxable income and accounting income originating in one period; and
(ii) The difference so originated should be capable of reversal in one or more subsequent periods.
The Committee notes that as per the definitions quoted above, the reversal of the difference can take place at any time in future, i.e., without any time limit.
18. The Committee notes that in case HTM investments are treated as stock-in-trade for tax purposes, though there may be differences between valuation of the investments for tax purposes and accounting purposes at relevant dates, the cumulative effect on profit and loss account from the time of acquisition to the disposal of the investment is same both for accounting and tax purposes. Thus, the difference originating in one period is bound to reverse in one or more subsequent period(s). Therefore, the Committee is of the view that the difference between taxable income and accounting income attributable to the difference in valuation of the HTM securities is a timing difference. Accordingly, the Committee is of the view that the said timing difference should be considered for creation of deferred tax asset/liability in accordance with the provisions of AS 22.
19. As regards provision for bad and doubtful debts, the Committee notes that the querist has stated in paragraph 10 above that before actual write-off, provision is created and that as stated by the querist in paragraph 12 above, there might be difference between provision made for accounting purposes and provision allowed for income-tax purposes, leading to difference between accounting income and taxable income. Further, the querist has stated in paragraph 11 above that any other bad debts (other than the provision for the year) are allowed as a deduction under section 36 (1)(vii) of the ‘Act’, only if the total amount of bad debts written off exceeds the total amount of provision already allowed as a deduction under section 36 (1)(viia). The Committee notes section 36(1)(vii) reads as below:
“36. (1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 –
“(vii) subject to the provisions of sub-section (2), the amount of any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year;
Provided that in the case of an assessee to which clause (viia) applies, the amount of the deduction relating to any such debt or part thereof shall be limited to the amount by which such debt or part thereof exceeds the credit balance in the provision for bad and doubtful debts account made under that clause;
Explanation: For the purposes of this clause, any bad debt or part thereof written off as irrecoverable in the accounts of the assessee shall not include any provision for bad and doubtful debts made in the accounts of the assessee”.
Without expressing any view on the querist’s interpretation of the above provision of the ‘Act’, the Committee proceeds to examine the issue as per the information and interpretation given by the querist. Thus, provision for bad and doubtful debts precedes actual write-off in accounts and the said provision made in accounts is allowed as a deduction for tax purposes as a combination of provision and write-off over a period of time, if provision allowed as a deduction for tax purposes is less than the provision made in the accounts. In other words, the difference originating in one period is bound to reverse in one or more subsequent period(s). Withdrawal of excess provision, if any, also amounts to, in substance, reversal of timing difference. This may happen, for example, due to partial write-off and partial recovery of a loan. Therefore, the Committee is of the view that the difference between taxable income and accounting income attributable to provision for bad and doubtful debts is a timing difference. As noted in paragraph 17 above, there is no time limit for the reversal of timing differences. Accordingly, the Committee is of the view that the said timing difference should be considered for recognition of deferred tax implications in accordance with the provisions of AS 22. Further, AS 22 contains specific provisions on consideration of prudence for recognition of deferred tax asset, re-assessment of unrecognised deferred tax assets, review of deferred tax assets, write-off and reversal of the same in appropriate circumstances which should be considered while accounting for deferred taxes. In case a written-off loan/advance is subsequently recovered, either in whole or part, the same will be offered as income for both tax and accounting purposes and hence, there is no deferred tax implication in this regard.
D. Opinion
20. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 13 above:
(i) The difference between the value of investment as per the books of account and as per the records created for income tax purposes emerging for Held to Maturity investments should be considered for the purpose of deferred tax asset/ liability as per the provisions in respect of timing difference in accordance with AS 22.
(ii) The difference in the provision for bad debts (Provision for Non Performing Assets) as per the books and as per income-tax is a timing difference and, therefore, it requires recognition of deferred tax effect subject to the considerations of prudence in case of deferred tax asset, in accordance with AS 22, when the tax treatment is as explained by the querist.
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