The Madras High Court has held that a taxpayer following the mercantile system cannot omit accrued interest on advances to subsidiaries merely on the plea of poor financial condition of the subsidiaries or commercial expediency, particularly where the debt continues to retain its original character and has not been written off in accordance with law.
The Court further held that, after April 1, 1989, deduction for bad debts under Section 36(1)(vii) of the Income Tax is allowable only upon actual write-off as irrecoverable in the accounts, and not on the basis of a mere provision or an inadequately supported consolidated write-off. Acceptance of such claim without examining party-wise details and proper accounting treatment is unsustainable.
Accordingly, the High Court set aside the orders of the CIT(A) and the ITAT and remitted both matters to the CIT(A) for fresh consideration of all grounds after giving opportunity of hearing to the parties.
The Division Bench comprising Dr Justice G. Jayachandran and Justice Shamim Ahmed observed that a taxpayer following the mercantile system is required to bring accrued income into total income, and deviation from the earlier practice of charging interest on advances to subsidiaries could not be justified merely by asserting poor financial condition of the subsidiaries or commercial expediency, particularly when the debt itself had not been written off in accordance with law.
The Bench pointed out that the CIT(A) and the ITAT had misapplied the decision in the case of S.A. Builders. According to the Bench, S.A. Builders Ltd vs Commissioner of Income-Tax (Appeals), Chandigarh [(2007) 288 ITR 1 (SC)] dealt with allowability of interest on borrowed funds advanced to a sister concern on grounds of commercial expediency, whereas in the present case the advances to subsidiaries had earlier been interest-bearing and there was no demonstrated change in the character of those advances. The ITAT was also faulted for introducing fresh reasons, such as treating one advance as capital subscription and another as running account advance, though such case was neither pleaded nor supported by the record.
On bad debts, the Bench observed that after April 1, 1989, deduction under Section 36(1)(vii) requires actual write-off as irrecoverable in the accounts, and a mere provision for bad and doubtful debts is insufficient. It noted that proper accounting treatment and compliance with Sections 36(1)(vii) and 36(2) are mandatory. The Bench also found that the CIT(A) and the ITAT accepted the respondent’s consolidated head office write-off without proper reasons and without production of party-wise debtor details or branch records to rule out escaped income.
With respect to the Rs.17.72 crore issue for AY 2004-05, the Bench observed that the respondent had claimed expenditure relating to redemption premium/interest on deep discount bonds converted into term loans, though such amount remained unpaid and was later waived by UTI on one-time settlement. The Bench found the ITAT’s finding unsatisfactory because it did not specify what documents in the paper book justified reversal of the Assessing Officer’s disallowance, and because Annexure V to the audit report had not included the said amount in the disallowance under Section 43B. The Bench held that, if reappreciation of facts was required, the matter ought to have been remitted instead of allowing the claim on vague observations.
Briefly, the respondent company, primarily engaged in the manufacture of cement, filed its ITR admitting loss of Rs.174.21 crores for the AY 2004-05. In scrutiny assessment, the AO disallowed deduction under Section 35D, interest not recognised on advances to subsidiaries/associates, bad debts, provident fund and ESI, and computed the assessed loss at Rs.146.37 crores. On appeal, the CIT(A) deleted the interest addition and bad debt disallowance, but upheld the Section 35D disallowance.
Again, for AY 2004-05, the respondent filed its return admitting loss of Rs.21.95 crores. The AO however made additions/ disallowances including share issue expenses, interest debited to share premium account of Rs.17.72 crores, depreciation on electrical items, and interest not recognised on advances to subsidiaries/associates, and assessed the income at Rs.21.89 crores. On appeal, the CIT(A) upheld the disallowance of share issue expenses, but granted relief on the issues of non-charging of interest on advances to subsidiaries/associates, disallowance of interest towards share premium on redemption of deep discount bonds, and depreciation on electrical items. The Tribunal affirmed the relief granted by the CIT(A).
Appearances:
Advocate T. Ravi Kumar, for the Appellant/ Revenue
Advocate R. Vijayaraghavan, for the Respondent/ Taxpayer
