Treaty non-discrimination and bad debt deduction rules govern tax treatment of bank payments and write-offs

The article discusses two tax issues for banks and non-resident payments. On bad debts under section 36(1)(vii), it explains that the proviso must be read with section 36(1)(viia) and that the record must show whether the written-off debts relate to rural or non-rural advances; where that factual position is unclear, the matter requires verification before deduction is finally allowed. On section 40(a)(i), it states that the India-USA treaty non-discrimination clause can prevent disallowance for non-deduction of tax at source when a comparable resident payment would not suffer the same disallowance, so the deduction cannot be denied on that basis.

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Issues: (i) Whether the proviso to section 36(1)(vii) had to be applied by aggregating bad debts relating to rural and non-rural advances for the purpose of allowing deduction. (ii) Whether disallowance under section 40(a)(i) could be sustained in respect of payments made to non-resident card companies in view of article 26(3) of the India-USA tax treaty.

Issue (i): Whether the proviso to section 36(1)(vii) had to be applied by aggregating bad debts relating to rural and non-rural advances for the purpose of allowing deduction.

Analysis: The allowance of bad debt under section 36(1)(vii) must be read with section 36(1)(viia), which separately deals with provisions for bad and doubtful debts in the case of scheduled banks. The earlier decision relied upon had treated clause (viia) as confined to rural advances, and had held that debts arising from non-rural advances were not controlled by the proviso to clause (vii). On the facts, however, the extent to which the written-off debts related to rural or non-rural advances was not from the record. The matter therefore required factual verification by the Assessing Officer in light of the applicable legal position.

Conclusion: The issue was remitted to the Assessing Officer for fresh examination, and no final allowance of the claim was granted at this stage.

Issue (ii): Whether disallowance under section 40(a)(i) could be sustained in respect of payments made to non-resident card companies in view of article 26(3) of the India-USA tax treaty.

Analysis: The payments were made for services rendered by the non-resident entities, and the disallowance had been made only because tax had not been deducted at source. The treaty's non-discrimination provision required that interest, royalties and other disbursements paid to a resident of the other contracting state be deductible under the same conditions as if paid to a resident. Since, under the law applicable for the relevant year, a similar payment to a resident could not be disallowed merely for want of tax deduction at source, the same treatment had to follow for the non-resident payees. The stated exceptions were held inapplicable on the facts.

Conclusion: The disallowance under section 40(a)(i) was not sustainable and the claim of deduction was allowed.

Final Conclusion: The appeal succeeded in part: one issue was sent back for reconsideration, while the other was decided in favour of the assessee and the corresponding disallowance was deleted.

Ratio Decidendi: A treaty non-discrimination clause requiring equal deductibility for payments to non-residents and residents can prevent disallowance for non-deduction of tax at source where a comparable resident payment would not suffer such disallowance under the domestic law.

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