The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that a provision created by a credit guarantee fund towards expected claim payouts is an allowable deduction when it is based on an independent actuarial valuation and represents an ascertained liability rather than a contingent liability.
The Bench of Rahul Chaudhary (Judicial Member) and Amarjit Singh (Accountant Member) directed the Assessing Officer to allow the deduction claimed by the Credit Guarantee Fund for Micro Units towards the provision for claim payouts for Assessment Year 2019-20.
The Tribunal partly allowed the assessee’s appeal and dismissed the Income Tax Department’s cross-appeal.
The appellant/assessee is a trust established under the Pradhan Mantri Mudra Yojana through a trust deed dated March 30, 2016. The National Credit Guarantee Trustee Company Limited acts as its trustee.
The trust was constituted to improve access to micro-credit by providing guarantee cover to banks, non-banking financial companies and other financial intermediaries that extend loans without collateral or third-party guarantees to eligible micro units. It charges guarantee fees from lending institutions in return for the guarantee cover.
For the relevant assessment year, the trust filed its income tax return declaring a total income of ₹127.07 crore. During scrutiny proceedings, the Assessing Officer noticed that it had claimed a deduction of ₹903.60 crore towards the provision for claim payouts. Its financial statements reflected a closing provision of ₹978.76 crore.
The Assessing Officer observed that the provision had been claimed on an accrual basis, whereas the guarantee fee was allegedly accounted for and offered to tax on a receipt basis. On this basis, the officer concluded that the trust was following an impermissible hybrid system of accounting.
Consequently, the Assessing Officer added the entire closing balance of ₹978.76 crore to the trust’s taxable income.
The trust challenged the addition before the Commissioner of Income Tax (Appeals), contending that it consistently followed the accrual system of accounting. It maintained that the provision was computed on the basis of a report obtained from an independent actuary and was, therefore, an allowable business expenditure.
The CIT(A), however, treated the provision as a contingent liability. It observed that the actuarial report had used an “ad hoc” rate and that a claim payout would materialise only when a borrower defaulted and the lending institution invoked the guarantee.
Nevertheless, the CIT(A) allowed a deduction of ₹221.51 crore representing the actual claim payouts made during the year, subject to the condition that the corresponding deduction had not already been allowed in an earlier year. It also deleted the addition relating to the opening provision balance of ₹75.15 crore.
The appellate authority accordingly granted total relief of ₹296.67 crore while sustaining the remaining disallowance. Both the trust and the Revenue approached the ITAT against the order.
The central question before the Tribunal was whether the provision for claim payouts created during the relevant financial year constituted an allowable deduction.
Examining the trust deed and the notified credit guarantee scheme, the ITAT found that the trust guaranteed payment to member lending institutions in the event of defaults on micro-loans extended to eligible borrowers.
Under the scheme, the guarantee cover commenced from the date on which the guarantee fee was paid. The lending institution could invoke the guarantee upon fulfilment of the stipulated conditions, including classification of the borrower’s dues as a non-performing asset.
The Tribunal rejected the Assessing Officer’s conclusion that the trust recognised guarantee fees purely on a receipt basis. It noted that payment of the guarantee fee triggered the commencement of the guarantee cover.
Accordingly, there was either no difference between the accrual and receipt of the guarantee fee or the fee was received before the corresponding guarantee risk accrued.
The ITAT accepted the trust’s submission that a guarantee fee was similar to an insurance premium paid at the commencement of the period covered. Once the guarantee fee was received, the trust’s corresponding obligation to discharge the guarantee in accordance with the scheme and the relevant agreement stood triggered.
The Tribunal held that the obligation to make a claim payout was a present liability, although the exact amount and timing of the payout depended on a borrower’s default and the claim made by the concerned lending institution.
It therefore rejected the Revenue’s argument that the liability was merely contingent.
The Bench also disagreed with the CIT(A)’s finding that the provision had been created on an ad hoc basis. It observed that the mere use of the expression “ad hoc rate” in the actuarial report could not establish that the entire valuation exercise was arbitrary.
The independent actuary had considered the structure of the scheme, including the condition that the first loss equivalent to 5% of the gross loan amount would be borne by the lending institution. From the remaining amount, the guarantee was restricted to a maximum of 50% of the amount in default, subject to an overall cap on claim payouts.
The actuary had also considered the absence of adequate historical experience, the applicable lock-in period and the differences between the scheme’s target borrowers and borrowers covered by other comparable lending programmes.
After considering these factors, the actuary adopted default rates considered reasonable for estimating the trust’s expected claim liability. The Revenue had not questioned the bona fides or independence of the actuarial valuation, the Tribunal noted.
The ITAT further observed that the CIT(A), by restricting the deduction to actual payouts, had effectively placed the trust on a payment-based system for this expenditure even though it followed the accrual system of accounting. The Tribunal held that such an approach could not be sustained.
The Bench also took note of the tax treatment adopted in the cases of other government-backed guarantee schemes administered by the same trustee. In those cases, the Income Tax Department had accepted similar provisions after conducting scrutiny proceedings.
The Tribunal recorded that no comparable addition had been made in the trust’s assessments for the immediately preceding Assessment Year 2018-19 and the succeeding Assessment Year 2021-22. It therefore found merit in the trust’s plea based on consistency.
The actual payout data also supported the actuarial estimate. According to the details placed before the Tribunal, the aggregate provisions for Assessment Years 2016-17 to 2022-23 amounted to approximately ₹6,170.91 crore, whereas the claims ultimately settled amounted to approximately ₹6,034.56 crore. The difference between the estimated provisions and actual payouts was only 2.21%.
For Assessment Year 2019-20 itself, the provision of ₹903.61 crore was lower than the actual claim payout of ₹926.55 crore, the Tribunal noted.
In view of these facts, the ITAT held that the provision had been created on the basis of an independent actuarial report after considering the relevant facts, the trust deed, the notified scheme and the governing agreements.
The provision therefore represented an ascertained liability eligible for deduction under the accrual system of accounting.
The Tribunal set aside the findings of both the Assessing Officer and the CIT(A) concerning the claim payout provision and directed the Assessing Officer to grant deduction for the provision created during the relevant previous year.
In reaching its conclusion, the Bench also relied on its earlier decisions in Credit Guarantee Fund for Micro and Small Enterprises v. ITO and Credit Guarantee Fund for Micro and Small Enterprises v. DCIT.
