Banking bad debt deduction depends on ordinary lending activity; earlier-year income test does not apply to banking debts.

Bad debt written off by a banking institution was treated as allowable where the bank carried on ordinary banking and lending, and the earlier special-statute exemption applied only to income, profits and gains, not to the banking business itself. In that setting, the banking-specific limb of section 36(2) applied: the debt had to represent money lent in the ordinary course of banking business, and the earlier-year income test did not govern such banking debts. The claim remained subject to recomputation under the proviso to section 36(1)(vii) and the deduction already allowed under section 36(1)(viia).

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Issues: Whether bad debts written off by a banking institution were allowable under section 36(1)(vii) read with section 36(2) of the Income-tax Act, 1961 where, in earlier years, only the assessee's income, profits and gains were exempt under the special statute and not the banking business itself.

Analysis: The assessee was a bank engaged in the ordinary course of banking and lending. The exemption under the special statute operated only on income, profits and gains, and did not exempt the business as such. On that footing, the earlier decisions dealing with sources of income wholly exempt from tax were held inapplicable. For a banking concern, the second limb of section 36(2) applied, namely that the debt represented money lent in the ordinary course of banking business, and the further condition that the debt must have been taken into account in computing income of an earlier year did not govern such banking debts. The Tribunal also noted that the Assessing Officer had not properly examined the deduction already allowed under section 36(1)(viia) while disallowing the claim under section 36(1)(vii).

Conclusion: The bad debt claim was allowable in principle in favour of the assessee, subject to recomputation with reference to the proviso to section 36(1)(vii) and the deduction under section 36(1)(viia).

Final Conclusion: The main disallowance was set aside in substance, while the ancillary challenge relating to the additional ground was not entertained, resulting in partial relief to the assessee.

Ratio Decidendi: Where a banking business is not exempt per se and the debt written off represents money lent in the ordinary course of banking, the bad debt deduction is governed by the special banking limb of section 36(2), and the earlier-year income test does not apply.

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