Court Dismisses Revenue’s Appeal on Stale Drafts and Depreciation Claims

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Case Name: 

Commissioner of Income Tax Vs. Karnataka Vikas Grameen Bank (High Court of Karnataka)

ITA No. 100014 of 2014 C/w ITA No. 100013 of 2014

Date: 14th December 2015

Key Takeaways:

• The court held that unclaimed stale drafts and pay orders do not constitute taxable income under Section 41(1) (of Income Tax Act, 1961).
• The bank’s method of accounting, valuing securities at cost or market value, whichever is lower, was upheld, allowing them to claim depreciation on securities held to maturity.
• The decision reinforces the principle that consistent accounting practices accepted by the Revenue cannot be arbitrarily challenged.

Issue:

1. Should unclaimed stale drafts and pay orders be considered taxable income under Section 41(1) (of Income Tax Act, 1961)?
2. Can the bank claim depreciation on government securities held to maturity?

Facts:

• The Karnataka Vikas Grameen Bank had unclaimed stale drafts and pay orders amounting to Rs. 58,31,581/-.
• The bank also claimed depreciation on government securities held to maturity, valued at Rs. 17,59,00,087/-.
• The Revenue challenged these claims, arguing they should be taxed or disallowed.

Arguments:

• Revenue’s Argument: The unclaimed amounts should be taxed as profits under Section 41(1) (of Income Tax Act, 1961) since they remained unclaimed in the bank’s hands. The depreciation claim on securities held to maturity was not valid as these were investments, not stock-in-trade.
• Bank’s Argument: The unclaimed amounts are liabilities, not profits, as they could be claimed by payees. The bank consistently followed an accepted accounting method, valuing securities at cost or market value, whichever is lower, allowing for depreciation claims.

Key Legal Precedents:

• T.V. Sundaram Iyengar & Sons Limited: The Supreme Court held that unclaimed amounts do not automatically become taxable income if the liability to repay remains.
• United Commercial Bank: The Supreme Court ruled that consistent accounting practices should be respected, allowing for depreciation claims even if securities are held to maturity.

Judgement:

The court dismissed the Revenue’s appeal, ruling in favor of the bank. It held that the unclaimed stale drafts and pay orders do not constitute taxable income under Section 41(1) (of Income Tax Act, 1961). The bank’s accounting method was upheld, allowing depreciation on securities held to maturity.

FAQs:

Q1. Why were the stale drafts not considered taxable income?

• The court found that these amounts are liabilities, not profits, as they could still be claimed by the payees.

Q2. How does this case affect other banks?

• It reinforces the principle that consistent and accepted accounting practices cannot be arbitrarily challenged by the Revenue.

Q3. What does ‘held to maturity’ mean for securities?

• It means the securities are intended to be held until they mature, but the bank can still claim depreciation if it follows a consistent accounting method.

Q4. Can the Revenue appeal this decision?

• The decision can be appealed, but the court’s ruling is based on established legal precedents, making a successful appeal challenging.

Though these two appeals are listed for admission, with consent of learned Counsel for the parties, they are taken up for final disposal.

2. Both appeals have been presented by the Revenue challenging the common order dated 28.11.2013 passed by the Income Tax Appellate Tribunal, Bengaluru Bench “C” in ITA No.112/BANG/2012 and ITA No.226/BANG/2012 raising the following substantial questions of law:-

1. Whether on the facts and circumstances of the case and in law the Tribunal was right in deleting the addition made by the assessing authority u/s.41(1) (of Income Tax Act, 1961), towards the unclaimed ‘stale draft and pay orders’, and as such there was cessation of liability on an amount of Rs.58,31,581/-?

2. Whether on the facts and circumstances of the case and in law the Tribunal was right in upholding the depreciation claimed by the assessee at Rs.17,59,00,087/- on investments on government securities “held to maturity” when such securities were held as a investments and not as ‘stock-in-trade’?

3. Briefly stated the facts of the case are,

assessee is a Regional Rural Bank registered under

the Schedule of Reserve Bank of India. It caters to

the needs of Agricultural and Cottage Industry

sectors. It makes investment in Government and

other securities. For the assessment year 2007-08,

assessee declared a taxable income of

Rs.94,26,91,495/-. Assessment was completed and

an income of Rs.112,45,33,700/- was assessed

against the returned income of Rs.94,26,91,495/-

by disallowing Rs.17,59,00,087/- claimed towards

depreciation on investment; Rs.87,224/- claimed

under Section 14A (of Income Tax Act, 1961); Rs.23,040/- towards

Commission on Locker Rent; and Rs.58,31,851/-

towards Stale Drafts and Pay Orders.

4. For the assessment year 2008-09, the

assessee filed it’s income declaring an income of

Rs.93,25,06,010/- as per revised return.

Assessment for the said period was also completed

and the income was determined at

Rs.102,66,57,128/- by disallowing

Rs.2,47,52,075/- deduction claimed under Section

36(1)(viia); Rs.6,74,91,000/- towards deductions

claimed under Section 36(1)(viii) (of Income Tax Act, 1961); Rs.68,478/-

claimed under Section 14A (of Income Tax Act, 1961); Rs.2,61,911/- claimed

under loss of sale of assets; Rs.13,94,212/- claimed

as exemption towards tax on Stale Drafts;

Rs.1,82,112/- claimed towards Commission paid to

Pigmy Agents; and Rs.1,330/- towards Locker Rent.

5. Assessee challenged both assessment

orders for the years 2007-08 and 2008-09 before

CIT(Appeals) Hubballi. Commissioner by Order

dated 30.11.2011 allowed the said appeals in part

by deleting disallowance claimed towards

depreciation on investment and Locker Rent in

respect of assessment year 2007-08 and deductions

claimed under Section 36(1)(viia) (of Income Tax Act, 1961), 36(1)(viii) (of Income Tax Act, 1961) and

Loss on Sale of Assets for the assessment year

2008-09.

6. Aggrieved by the Order passed by CIT

(Appeals), both Revenue and Assessee preferred

appeals before the Tribunal. Assessee presented

ITA No.112/BANG/2012 for the year 2007-08 and

ITA No.113/BANG/2012 for the year 2008-09.

Revenue presented ITA No.226/BANG/2012 for the

year 2007-08 and ITA No.227/BANG/2012 for the

year 2008-09. All the four appeals were disposed of

by the common impugned order.

7. Tribunal, by the impugned order upheld

the contentions of assessee and deleted the addition

made by the assessing authority:

(i) under Section 41(1) (of Income Tax Act, 1961),

1961 (‘Act’ for short) towards unclaimed ‘Stale

Drafts and Pay Orders’ whereunder assessing

authority had disallowed a sum of

Rs.58,31,851/-;

(ii) disallowance of Rs.17,59,00,087/- towards

depreciation on investment.

8. Challenging the order passed by the

Tribunal by raising substantial questions of law

stated supra, Revenue has preferred these appeals.

9. Heard Sri Y.V. Raviraj, learned Counsel

for the appellants and Sri A.Shankar, learned

Counsel for respondent-assessee.

10. Addressing arguments in support of the

questions of law raised by the Revenue, Sri Y.V.

Raviraj, learned Counsel submitted that the

Tribunal fell in error in reversing the concurrent

findings of the assessing authority and the First

Appellate Authority namely, the CIT (Appeals) with

respect to disallowance of ‘Stale Drafts and Pay

Orders’ and deleting the sum of Rs.58,31,851/-

added by the assessing authority under Section

41(1) of the Act. He strenuously contended that

admittedly, the said amount came into the hands of

the assessee as the purchasers of DD/Pay Orders

had not claimed/encashed them. Therefore, the

assessing authority was right in coming to the

conclusion that the said amount which remained

unclaimed in the hands of the assessee was ‘profit’

chargeable to tax under Section 41(1) (of Income Tax Act, 1961). He

further contended that the Tribunal misguided itself

by placing reliance on the Judgments rendered by

Co-ordinate Benches of the Tribunal in the case of

Canara Bank (ITA No.390/BANG/2011 dated

8.6.2012) and Vijaya Bank (ITA No.455/BANG/2011

dated 22.6.2012). He further contended that the

Judgments of the Tribunal on this issue are

unsustainable in law in as much as, on the face of

it, the unclaimed amount had remained in the

hands of the assessee and chargeable to tax under

Section 41(1) (of Income Tax Act, 1961).

11. In support of the second question of law,

namely, the depreciation on Investments in

Government Securities “held to maturity”, learned

Counsel for the Revenue contended that the

Tribunal grossly erred in rejecting it’s appeal by

confirming the order passed by the CIT (Appeals).

He submitted that Reserve Bank of India (RBI) is the

Controlling Authority of all Banks and has laid

down clear guidelines for Classification of Securities

held in the following manner:-

(i) Held to maturity;

(ii) Available for sale; and

(iii) Held for trading.

12. He further contended that it is mandatory

for the Banks to strictly comply with the guidelines

issued by the RBI from time to time. Admittedly,

assessee had written off a sum of Rs.17,59,00,087/-

by claiming depreciation on investments by showing

it as ‘Loss on Valuation of Securities’. The said

figure was arrived at by the assessee on the premise

that the market value of the securities held as on

31.3.2007 was less than the cost of securities.

Accordingly, the assessee had written off the same

in its Books of Accounts on the principle of “Cost or

Market Value, whichever is less applicable to the

valuation of closing stock”. Learned Counsel

strongly assailing the correctness of assessee’s

claim on depreciation, submitted that the same

runs counter to the CBDT’s instruction No.17/2008

dated 26.12.2008, which was correctly applied by

the assessing authority. He further submitted that

the securities were admittedly “held to maturity” and

therefore could not have been subjected to

depreciation. The reasoning adopted by the First

Appellate Authority as also the Tribunal defeats the

logic in as much as the concept of “held to maturity”

would loose its sanctity and relevance if the

assessee is permitted to claim depreciation having

declared the securities under the said

nomenclature. He contended that the classification

“held to maturity” displays a glowing description

that the assessee would get back the realizable

value of security only upon its maturity.

Consequently, the assessee was not entitled for the

benefit of depreciation as was rightly held by the

assessing authority.

13. With the above submissions, learned

Counsel for the Revenue prayed for allowing these

appeals.

14. Per contra, learned Counsel for the

assessee Sri A. Shankar, strongly supporting the

impugned order submitted that both questions of

law raised by the Revenue are wholly untenable.

Issues involved in these appeals are no more res

integra. Amplifying his contentions, reiterating the

grounds urged before the Tribunal, he submitted

that the amount which remained in the hands of

the Bank pursuant to a draft or a pay order

becoming stale is not an income in the hands of the

assessee. He adverted to Section 41(1) (of Income Tax Act, 1961)

and contended that by no stretch of imagination,

the amount which had remained in the hands of the

assessee could be considered to fall within the

definition of ‘profit chargeable to tax’ under the said

provision. According to him, the said amount is a

liability which the Bank will have to discharge as

and when a claim is lodged by the holder/payee of a

draft/pay order. The amount held by the assessee

is governed by the guidelines issued by the RBI in

that behalf. The sum and substance of his

argument is that the amount which had remained

in the Bank pursuant to a draft/pay order becoming

stale cannot be construed as ‘profit chargeable to

tax’. In support of his contentions, he placed

reliance on the judgment of the Hon’ble Supreme

Court in the case of Commissioner of Income Tax v.

T.V. Sundaram Iyengar & Sons Limited reported in

(1996) 222 ITR 344.

15. With regard to the second question of law

namely, the depreciation claimed in respect of the

investments in Government Securities “held to

maturity”, he contended that the assessee is

consistently following a particular method of

accounting namely ‘at cost or market value,

whichever is lower’. He placed reliance on the

judgment of the Hon’ble Supreme Court in the case

of United Commercial Bank v. Commissioner of

Income Tax reported in ITR 240 355 (SC) and

submitted that the Apex Court has held therein that

preparation of balance sheet in accordance with the

statutory provisions would not in any way disentitle

an assessee in submitting Income Tax returns on

the real taxable income in accordance with the

consistent method of accounting adopted by the

assessee. He further submitted that this judgment

of the Hon’ble Supreme Court has been followed by

a Division Bench of the Principal Bench of this

Court in ITA No.172/2009 (The Karnataka Bank

Limited v. the Assistant Commissioner of Income Tax)

disposed of on 11.3.2013. Thus, the contention of

assessee is that although assessee had declared the

securities as “held to maturity”, in view of the

authoritative pronouncement of the Apex Court,

assessee was entitled to claim depreciation as was

rightly held by the CIT (Appeals) and confirmed by

the Tribunal by the impugned order. Accordingly, he

prayed for dismissal of these appeals.

16. We have bestowed our careful

consideration to the rival contentions urged by the

parties and perused the material papers and the

judgments relied upon by the learned Counsel for

the assessee.

17. Re-question with regard to ‘stale drafts

and pay orders’.

It is not in dispute that the sum of

Rs.58,31,581/- had remained in the hands of the

assessee upon the drafts and pay orders issued by

the Bank having been rendered stale. The assessing

authority sought to categorise the said sum within

the meaning of ‘profit chargeable to tax’ under

Section 41(1) (of Income Tax Act, 1961). Section 41(1) (of Income Tax Act, 1961) reads as

follows:-

“41.(1) Where an allowance or

deduction has been made in the

assessment for any year in respect of loss,

expenditure or trading liability incurred by

the assessee (hereinafter referred to as the

first-mentioned person) and subsequently

during any previous year,-

(a) the first-mentioned person has

obtained, whether in cash or in any

other manner whatsoever, any amount

in respect of such loss or expenditure

or some benefit in respect of such

trading liability by way of remission or

cessation thereof, the amount obtained

by such person or the value of benefit

accruing to him shall be deemed to be

profits and gains of business or

profession and accordingly chargeable

to income-tax as the income of that

previous year, whether the business or

profession in respect of which the

allowance or deduction has been

made is in existence in that year or

not; or

(b) the successor in business has

obtained, whether in cash or in any

other manner whatsoever, any amount

in respect of which loss or expenditure

was incurred by the first-metnioned

person or some benefit in respect of

the trading liability referred to in

clause (a) by way of remission or

cessation thereof, the amount obtained

by the successor in business or the

value of benefit accruing to the

successor in business shall be deemed

to be profits and gains of the business

or profession, and accordingly

chargeable to income-tax as the

income of that previous year.”

18. A careful perusal of the above provision

leads us to infer that Section 41(1) (of Income Tax Act, 1961) can be pressed

into service when an allowance or deduction is

sought to be made in respect of loss, expenditure or

trading liability is incurred by the assessee. In the

instant case, the sum of Rs.58,38,581/- has

remained with the assessee owing to the fact that

the payees or holders of the draft/pay orders had

not encashed them. The language employed by the

legislature being unambiguous, it would be

incongruous to construe the said sum as either a

loss, expenditure or trading liability incurred by the

assessee. While dealing with a situation of

unclaimed amount, the Hon’ble Supreme Court in

the case of T.V. Sundaram Iyengar1, has held as

follows:-

“12. We are unable to uphold the

decision of the Tribunal. The amounts

were not in the nature of security deposits

held by the assessee for performance of

contract by its constitutents. As it appears

from the facts of the case, the amounts

were depleted by adjustments made from

time to time. The CIT(A) found that the

assessee wrote back the amounts to its

P&L a/c because the various trading

parties did not claim these amounts for a

long time. The amounts represented credit

balances in the name of the trading

parties and was taken to its P&L a/c. The

CIT(A) held that these amounts were not

revenue receipts but were of capital

nature. The provisions of s.41(1) were not

attracted in the facts of this case because

the assessee’s liability to pay back the

amounts to its customers had not ceased.

The Tribunal agreed with this view."

(underlining is by us)

19. The Tribunal adverting to the above

ruling has rightly deleted the sum of Rs.58,38,581/-

added by the assessing authority by holding it as

unsustainable in law.

20. Re-depreciation claimed on securities

“held to maturity”.

The assessee’s claim on depreciation of

Rs.17,59,00,087/- and consequential write off in

the Books of Accounts was disallowed by the

assessing authority on the premise that the

securities categorised and accounted as “held to

maturity” were indeed investments and could not be

considered as stock-in-trade.

21. Learned Counsel for the assessee is right

in his submission that the issue with regard to the

question as to whether an assessee would be

entitled to claim depreciation in the given

circumstances stands covered by the judgment in

the case of United Commercial Bank2, wherein the

Hon’ble Supreme Court has held as under:-

“In our view, as stated above,

consistently for 30 years, the assessee

was valuing the stock-in-trade at cost for

the purpose of statutory balance sheet,

and for the income-tax return, valuation

was at cost or market value, whichever

was lower. That practice was accepted by

the Department and there was no

justifiable reason for not accepting the

same. 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 the

method of accounting adopted by the

assessee consistently and regularly. That

cannot be dis-carded 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.

In the result, the appeal is allowed.

The impugned order passed by the High

Court is set aside. The question referred

by the Tribunal are answered in favour of

the assessee and against the Revenue.”

(underlining is by us)

22. Admittedly in the instant case, assessee

was following the method of accounting namely, “at

cost or market value, whichever is lower”. Further,

it is not in dispute that this practice was accepted

by the Revenue throughout. Thus, in the light of the

above pronouncement of the Hon’ble Supreme

Court, notwithstanding the preparation of the

balance sheet and describing the security under a

particular nomenclature in compliance with the

directions/instructions issued by the RBI, the

assessee would be lawfully entitled to submit the

tax returns on the real taxable income in

accordance with the method of accounting

consistently and regularly adopted.

23. In the light of above discussions, we are

of the considered view that the questions of law

raised by the Revenue do not merit any

consideration. Appeals fail and accordingly stand

dismissed without any orders as to costs.

Sd/-

JUDGE

Sd/-

JUDGE