Taxation of banks or financial institution in respect of interest on bad or doubtful debts

ThinkLedger Editorial
4 min read

Introduction

In case of public financial institution, scheduled banks, etc. interest in respect of the specified categories of bad or doubtful debts shall be chargeable to tax in the year of receipt or in the year of credit, whichever is earlier.

1. About

Entities create the provision for bad-debts that may arise in future. This provision is created on estimation basis on the amount of bad debt that may arise from accounts receivable that have been issued but not yet collected. The provision for bad-debts are allowed as deduction only to the specified entities (i.e., scheduled bank, non-scheduled bank, co-op. bank) under Section 31(1) [Table S. No. 1]. While as the actual bad-debts are allowed as deduction to every assessee in accordance with the provision of Section 31(2).

As banks or financial institutions have to recognize interest on debts or advances on accrual basis, the interest on the bad or doubtful debts would be taxable even if the recovery of such interest is doubtful. Thus, this provision gives relief to the banks or financial institutions from such taxability.

In the case of following assessees, income by way of interest on the prescribed bad or doubtful debts is chargeable to tax in the year of receipt or in the year of credit of such income in the profit and loss account, whichever is earlier:

(a) A public financial institution;

(b) A scheduled bank;

(c) A co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank;

(d) A state financial corporation;

(e) A state Industrial investment corporation; and

(f) Non-banking financial company of such class as may be notified by the Central Government.

This provision shall apply to the interest income in respect of the bad and doubtful debts as prescribed under Rule 42.

2. Bad & Doubtful debts [Rule 42]

The above-mentioned banks and financial institutions may avail the benefit under this provision in respect of interest on bad and doubtful debts relating to the following categories:

(a) Loan or advance;

(b) Account.

2.1. Loan or advance

The benefit can be claimed for a loan or advance in the following cases:

(a) Interest or principal instalment remains unpaid for more than 180 days; or

(b) Account is classified as ‘out of order’ in the case of an overdraft or cash credit account; or

(d) Principal instalment or interest remains overdue for two crop seasons in the case of short-duration crops; or

(e) Principal instalment or interest remains overdue for one crop season in the case of long-duration crops; or

(f) Liquidity facility amount remains outstanding for more than 180 days in a securitisation transaction carried out under the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021; or

(g) In respect of derivative transactions, receivables representing the positive mark-to-market value of a derivative contract remain unpaid for 180 days from the specified due date for payment.

Notes:

(a) An overdraft or cash credit account shall be treated as “out of order” in the following cases:

• Outstanding balance in the overdraft or cash credit account continuously exceeds the sanctioned limit or drawing power for 180 days; or

• Outstanding balance remains within the sanctioned limit or drawing power, but there are no credits in the account for a continuous period of 180 days, or the credits during the previous 180 days are insufficient to cover the interest debited during that period.

(b) Long duration crop means crop with a crop season longer than one year.

(d) The crop season for each crop means the period up to harvesting of the crops raised, as may be as determined by the State Level Bankers" Committee in each State.

2.2. Account

In relation to an account, the following situations are covered:

(a) A working capital borrowing account shows irregular drawings for a continuous period of 180 days, even if the business is operational or the borrower’s financial position is satisfactory. For this purpose, if the outstanding amount is based on stock statements older than six months, the account shall be treated as irregular; or

(b) The regular or ad hoc credit limits are not reviewed or renewed within 180 days from the due date or the date of ad hoc sanction; or

(c) where the value of the security has declined, and its realisable value is less than 50% of the value assessed by the bank or accepted by the Reserve Bank of India during the last inspection; or

(d) Realisable value of the security, as assessed by the bank, approved valuers, or the Reserve Bank of India, is less than 10% of the outstanding amount in the borrowing accounts.

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.