ITAT allows deduction of provision made for cash loss due to embezzlement by Bank employees

The assessee is a District Central Co-operative Bank carrying on banking business governed by Karnataka State Co-operative Societies Act, 1959, and the rules and regulations of NABARD and also RBI Guidelines for Banking activities. The assessee had debited an amount of Rs. 7,50,99,000/- as provision for misappropriation in the P & L account and computed income from business after such deduction. The assessee had reduced this amount from loans and advances in the balance sheet. The assessee explained that the co-op department of Government of Karnataka conducted an enquiry on misappropriation in one of assessee’s branch at Honalli and submitted a report. The assessee submitted that a fraud occurred in the bank and was under enquiry by the Co-operative Societies Enquiry office under the Karnataka Co-operative Societies Act, 1959, under section 64. It is very difficult to recover the misappropriated amount [if the bank recovers as an affidavit is already filed the bank that it will admit the recovered amount as income] the recovery of the fraud amount depends upon the Sec.64 enquiry report under the Co-operative Spcoetoes Act. 1959.

The AO, after examining the claim of the assessee, held that there was a reasonable prospect of getting the misappropriated amount back since the bank has already attached the assets of the persons who indulged in fraud. The assessee bank did not prefer claim before the insurance company, though the bank is registered with insurance company for possible damage. Further, as per the audit report dated 13.01.2012 of M/s Bagrecha & Singhvi, Bellary “A perusal of the Bankers Indemnity Policy taken by the banker with National Insurance Company Limited shows that the sad policy provides cover for the loss arising due to forgery or alteration due to dishonesty or criminal act of employee but it has been observed that no claim has been preferred by the banker in respect of employee fraud reported in Honalli Branch during the year.”

Aggrieved by the order of the AO, the assessee preferred appeal before the CIT(A). The CIT(A) deleted the addition made by the AO on the basis that it was a write off bad debts and the assessee is entitled to claim deduction of bad debts purely on the basis of mere write off.

Aggrieved by the order of the CIT(A), Revenue has referred the present appeal before the Tribunal.

Income Tax Appellate Tribunal (ITAT) pointed out that the CIT(A) has proceeded on a wrong presumption that the sum claimed as a deduction was on account of the write-off of bad debts. This presumption of the CIT(A) is erroneous because factually it was a case of embezzlement by the employee of the assessee that resulted in a loss to the bank.

However, in the course of the hearing, ITAT’s attention was drawn to a circular of the CBDT which deals with the question of when a deduction on account of loss on account of embezzlement can be allowed as a deduction.

On perusal of the circular, it is clear that loss due to embezzlement by employees should be treated as a loss incidental to the business. To this extent, in this case, there is no doubt that the assessee suffered a loss on account of embezzlement in the sense a fraud was carried out in one of its branches. With regard to the year in which the deduction is to be allowed, the circular lays down that the loss should be allowed as a deduction in the year in which the embezzlement was discovered. Factually, this aspect was never examined nor substantiated by the assessee either before the AO or the CIT(A).

ITAT therefore in view of the circular set aside matter to the AO for consideration afresh in the light of the CBDT’s circular referred to above only on the question as to in which year the loss has to be allowed as deduction.