PROVISION FOR BAD AND DOUBTFULL DEBT

PROVISION FOR BAD AND DOUBTFULL DEBT WHICH WAS NOT ALLOWED EARLIER IN FULL IN THE ASSESSMENT YEAR CANNOT BE TAXED AS INCOME IN THE YEAR OF WRITE BACK

Each and every business entity working in India is guided by Income Tax Act, 1961. The income which a business entity earns is taxed following the relevant provisions of the Income Tax Act, 1961. There are a lot of section following which tax authority has to decide whether an income is taxable or not. One such section relates to the provisions for bad and doubtful debt. It is covered under section 36(viia)(b) of the Income Tax Act, 1961.

Section 36(viia)(b) is an important section as it allows a bank which though not incorporated India but being a bank under a law of any country outside India is allowed a deduction of five percent of the total income(computed before making such provision and Chapter VI) on account of provision for bad an doubtful debt.

In the banking sector the scope of default by customer is large so there is large provisions created for such default but under the Income Tax Act, 1961 there is a ceiling limit of five percent of the total income beyond which it can create any provision. So there remains some provision which remain unutilized. But in case if it recover some portion of the provision and write backs the amount in the books, whether such income chargeable tax or not is a question.

This can be best understood by a case involving Bank of Tokyo Mitsubishi UFJ Ltd(BTM) and the income tax department.

BTM is bank under the laws of Japan. The bank carries out its operation in India through its branches established in India. The profits earned by its permanent establishment were taxed by the income tax authorities.

Since being a foreign bank it was allowed a deduction under section 36(viia)(b) of the Income Tax Act, 1961 of an amount being not more than five percent of the total income. But since it being a foreign bank maintains its own provision for bad and doubtful debt and therefore because of the ceiling limit, the provisions created over years was not allowed as deduction.

Now during a year BTM made a gross provision and after writing back an amount which was recovered. The resultant figure was then added back to the total income to compute the Net Income.

When the Assessing Officer was assessing the return of income he allowed the deduction under 36(viia)(b) but he also charged the amount recovered on the grounds that no sufficient information was provided regarding the amount recovered and even it was from write back the amount was chargeable to tax assuming it was from a amount already provided as deduction earlier.

BTM was not happy with this assessment and appealed before the Commissioner of Income Tax (Appeal).

BTM won the case. But the income tax authority not happy with decision appealed in the Tribunal.

The Tribunal was of the view that since the department cannot produce any proof that the write off amount taxed was allowed as deduction in any of the earlier previous years. The deduction allowed under section 36(viia)(b) being five percent of the total if recovered can only be taxed as income in the year of recovery. So the decision again went in favor of BTM and the Assessing Officer was ordered to satisfy himself if the amount recovered was from provisions made earlier.

The ultimate conclusion is that an amount which is recovered and written back by a bank can only be subject to tax as an income only if it was allowed as deduction any of the earlier previous years. Until and unless this happens the amount is not subject to tax.

Routers and switches should be classified as part of computers and be eligible for 60% depreciation

Routers and switches should be classified as part of computers and be eligible for 60% depreciation

In a recent decision Special Bench (SB) of the Mumbai Income Tax Appellate Tribunal in the case of Datacraft India Ltd. (Taxpayer) [ITA No.7462 & 754/ Mum/ 2007]on the issue of whether routers and switches can be classified as computer entitled to depreciation at 60% or have to be classified as general plant and machinery entitled to depreciation at 25%, under the provisions of the Indian Tax Laws (ITL) held that the definition of computer should not be restricted to the central processing unit (CPU) of computer, but should also extend to all the input and output devices which support computer in the receipt of input and outflow of output to and from computer. In view of the broader definition given to computers, routers and switches, which form part and parcel of computer, also qualify for depreciation at 60%.

Background and facts

The Taxpayer is engaged in the business of data communication, design, development, purchase and sale of networking products, their maintenance and installation etc.

For tax years 2001-2002 and 2002-2003, the Taxpayer claimed depreciation on routers and switches at the rate of 60% by classifying them as ‘computers’.

The Tax Authority rejected Taxpayer’s contention and held that routers and switches, being equipments which are used as networking tools, would fall under the general category of ‘plant and machinery’ and the rate of depreciation applicable would be 25%.

On appeal by the Taxpayer against the Tax Authority’s order, the first appellate authority ruled in favor of the Taxpayer and held that routers and switches, being an indispensable part of computer just like keyboard or mouse or printer, should form part of computer.

The Tax Authority preferred further appeal before the second appellate authority (Tribunal). Special Bench (SB) was constituted to decide on the issue of classification of routers and switches as ‘computer’ or ‘plant and machinery’ for the purposes of depreciation allowance.

Tax Authority’s contentions

Routers are nothing but telecommunication device meant for transmitting data from one computer to another or from one network to another and, hence, are not computers.

Definition of computer, given in the Information Technology Act, 2000 (Info Tech Act), cannot be considered for the purpose of granting depreciation under the ITL, as the scheme of both the laws is entirely different.

Oxford dictionary defines computer functions to mean performance of logic, arithmetic, data storage, communication and control functions. Since routers do not perform such processing functions, they cannot be treated as computer.

Taxpayer’s contentions

Meaning of computer should not be restricted to processing device alone. It should also mean the essential input/output devices which facilitate the operation of computer.

Routers and switches are input/output devices and are attached to computer. They have no independent utility and have to work necessarily with computer and are considered as integral part of computer.

SB decision

Upholding the contentions of the Taxpayer, the SB held as follows:

In the absence of specific definition of the term in the ITL, it is understood as per common parlance and commercial parlance tests. Test of predominant function and usage is applied in understanding such undefined terms. In common sense, computer is popularly understood to mean any electronic or other high speed data processing device which performs ‘logical, arithmetic and memory functions on data’ and includes all input and output devices which are connected to it.

The scope, purpose and substance of Info Tech Act are quite different from the context of the provisions of the ITL. However, the meaning of the term ‘computer’ as given in Info Tech Act matches with common parlance meanings. Such a meaning can, hence, be considered as an aid in understanding the term ‘computer’ for ITL purposes.

Routers can best be equated with a hardware device that routes data from a local area network to another network connection. A router acts like a coin sorting machine, allowing only authorized machines to connect to other computer systems.

The main function of routers is to receive data from one computer and make it available to another computer for further processing and viewing. As a result, routers have an essential function of supporting commercial organization to facilitate the flow of data from one computer to another for processing or storage.

Switches are shorter version of routers and perform functions which are similar to routers within a limited sphere.

Like computer hardware, a router in itself is not a computer as it neither performs any logical, arithmetic or intermediary functions on data nor does it manipulate or process data. However, routers and switches can be classified as computer hardware when they are used along with a computer and their functions are integrated with a computer.

The SB compared the CPU of computer akin to the human brain and observed that as the brain alone is not considered as the body; the CPU alone cannot be described as a computer. All devices such as keyboard, mouse etc. would also form part of computer.

[2] The SB also commented on the decisions of the Kolkata Tribunal in the case of Samiran Majumdar [280 ITR 74] , relied by the Taxpayer, and the Mumbai Tribunal in the case of Routermania Technologies (P) Ltd. [3] [16 SOT 384], relied by the Tax Authority. The SB observed that the decision of the Kolkata Tribunal, holding printer and scanner are depreciable as ‘computers’, was a better view of the matter than the view of the Mumbai Tribunal. The Mumbai Tribunal had taken a narrower view and held that routers which did not perform logical, arithmetical or memory functions by manipulation of electronic impulses etc. are not computers.

The SB, however, clarified that machines or equipments such as television set, mobile phones etc., which take assistance of computer functions, are not computers.

Comments

A Special Bench is generally constituted when there are conflicting decisions of the Tribunals or the matter pending for adjudication is of considerable importance. It is also a well-settled convention to consider the Special Bench’s decision as binding on the division benches of the Tribunal.

The present decision should assist in addressing the principle that predominant function of the routers and switches determines its classification. On application of functional test, any ancillary and supplemental components of a computer which is essential in the working of computer would form part of computer.