A Resurgence of Bank Nationalisations

An offshoot of the global financial crisis has been the significant changes in economic policies in the developed world. The recent phenomenon relates to increasing calls from leading economists to nationalise troubled banks, particularly in the U.S. The concept of nationalisation was previously associated with the so-called ‘socialist’ economies, but is now becoming closer to reality even with proponents of the free market.

As Paul Krugman notes in his column in the New York Times, “Comrade Greenspan wants us to seize the economy’s commanding heights. O.K., not exactly. What Alan Greenspan, the former Federal Reserve chairman — and a staunch defender of free markets — actually said was, “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.” I agree.”

Further, Matthew Richardson and Nouriel Roubini, professors at New York University’s Stern School of Business note: “As free-market economists teaching at a business school in the heart of the world’s financial capital, we feel downright blasphemous proposing an all-out government takeover of the banking system. But the U.S. financial system has reached such a dangerous tipping point that little choice remains.” Such comments arise in the context of concerns regarding the continued viability of leading U.S. banks such as Citibank and Bank of America.

Apart from the policy rhetoric, nationalisations tend to invoke certain fundamental questions. Often, there is a conflict of interest between shareholders of banks (who tend to take a ‘haircut’, as they say, in a nationalisation by having to give up their shares at low values) and that of other stakeholders (such as tax payers and the public who suffer if Governments have to continually backstop troubled banks without being taken over). There is also the question of whether governments are in a better position to run businesses such as banks as opposed to the private sector.

These issues are not novel in the Indian context with a substantial part of the Indian banking industry being populated by nationalised banks. Many of these issues have been the subject matter of intense debates in 1969 and 1980 when several Indian banks were nationalised. Some of these were even litigated all the way in the Supreme Court of India (R.C. Cooper v. Union of India, AIR 1970 SC 564). What is interesting in the current scenario is that the revival of this debate in the U.S. and other countries has thrown the spotlight on the Indian experience with reference to bank nationalisations – while the analysis in the Knowledge@Wharton suggests caution regarding adopting the Indian model of nationalisation, an interesting fact reported yesterday is that Citibank’s market capitalisation has become less than that of the State Bank of India (which is not only India’s largest bank but is also in the public sector). The key difference, however, is that the recent moves recommend nationalisation as a temporary measure, while in India it has become a permanent feature (although several nationalised banks do have public shareholders and their shares are listed and traded on stock exchanges).

About the author

Umakanth Varottil

Umakanth Varottil is a Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

3 comments

  • The Post brings to one’s mind the annexed two recent News items. They bear on the sleeves the vexing but recalcitrant and aggressive way in which our countrymen in governance are traditionally accustomed to function; more often than not, having no regard to but to the detriment of ‘public interest’ – in its profound sense.

    The public shareholding in nationalized banks, if I remember right, was originally 51% and later reduced to 33%. As such, the managements of these banks have always been answerable to the public with regard to anything they do or omit to do having a direct or indirect impact against the shareholders’ interests.

    It was years before that the Executive constituted the Committee on Disputes (CoD) in pursuance of a recommendation made by the Apex Court in ONGC case. That happened when ONGC was a public sector undertaking, with the government-holding cent percent. The reason was obvious and could not have been faulted.

    However, what is intriguing, rather prima facie strongly objectionable/questionable is this: – Even after dilution of the government holding in ONGC, the CoD has continued, and been allowed, to have control in respect of disputes, particularly income tax and other tax disputes, to which ONGC is a party.

    All the more intriguing is, – as to why the nationalized banks should at all have been subjected to the control of CoD.

    One emphatically believes that, – this is clearly a matter on which the public shareholders as also the respective managements (be it of ONGC or the banks) have every right to forcefully question the Executive’s authority to interfere in their internal matters – under the Consitution as well as under the tax or other laws.

    ANNEXURE

    1. Public sector banks seek right to appeal in tax cases

    Citing that they have the responsibility to protect the interests of their minority shareholders, public-sector banks have sought the right to appeal in tribunals and high courts in income tax cases. In many instances, banks are not satisfied with the orders of the income tax commissioners (appeals) in cases of disputes over the assessment of the income tax of banks. Then, the banks are required to appeal to the income tax appellate tribunal. Also, in many cases, the Committee on Disputes does not permit banks to pursue the case before the appellate tribunal or high court. This refusal leaves no scope for judicial pronouncement in the case. All government-owned entities have to mandatorily take permission from the committee, if they decide to resort to litigation against government departments, failing which the tribunal or high court will not entertain the matter. Seeking a solution to the issue from the government, the Indian Banks Association (IBA) said, “With the process of disinvestments by the government, most public-sector banks have raised capital by issuing shares to the public.” Hence, these banks are no longer totally owned and controlled by the Central Government and they are required to protect the interests of other shareholders as well, the IBA added. The IBA has approached the government to permit banks to file appeals before tribunals since there is provision for the same in the Income Tax Act. The association further suggested that representatives of public sector entities, including banks, should be nominated on the Committee on Disputes to facilitate amicable resolution of disputes referred to it. – http://www.business-standard.com

    2. BANKS UNDER TAXMAN’S SCRUTINY

    The income-tax assessment of banks is generally considered an area of expertise, as it involves analysis of issues that are typical to banks that one does not come across in the cases of other taxpayers. CBDT Instruction The Central Board of Direct Taxes (CBDT) has issued Instruction No. 17/2008 (November 26, 2008) as a checklist for deductions in the assessment of banks. The trigger of this Instruction is a review of the assessment of banks carried out by the Comptroller and Auditor General of India (C&AG) which has observed that deductions of large amounts under different sections are being allowed by the assessing officers (AOs) without proper verification, leading to substantial loss of revenue. One of the most important provisions in relation to banks is a deduction under Section 36(1)(viia) in respect of provision for bad and doubtful debts ( for other assessees, deduction is available only on actual write off of bad debts — no deduction is available on provision basis). As banks are eligible for a deduction as regards provision for bad and doubtful debts, the deduction under Section 36(1)(vii) on actual write off of bad debt is restricted to the write off in excess of the provision for bad and doubtful debts made under Section 36(1)(viia). Write off vs provision An area of litigation between banks and the I-T department was the level at which the comparison between the write off and the provision under Section 36(1)(viia), that is, whether the opening balance of the provision as on April 1 should be considered or the closing balance as on March 31 (after current year’s provision). The Mumbai Tribunal in the Oman International Bank SAOG vs DCIT (2005 92 ITD 76) and the British Bank of Middle East vs JCIT (2005 4 SOT 122) cases upheld the stand taken by the assessee bank and held that the admissible provision under Section 36(1)(viia) for the current previous year cannot be taken into account for computing deduction under Section 36(1)(vii), that is, the opening balance of the provision has to be considered. This view has also been expressed in other unreported decisions of the Mumbai and other Benches of the Tribunal. The CBDT has concurred with the view of the Tribunals in its Instruction. This is a welcome clarification from the perspective of banks and would reduce one area of dispute between banks and the Department. The other instructions of the CBDT in the context of Sections 36(1)(vii)/(viia) reiterate the law and do not give any fresh clarifications. Broken period interest Another area of long-standing dispute in the case of banks was the tax treatment of broken period interest (BPI) on purchase of Government securities (G-secs). As the interest on G-secs becomes due and payable only on coupon dates, a purchaser of G-secs has to pay interest to the seller from the previous coupon date till the date of sale, that is, for the period the G-secs are held by the seller. The department’s stand was that BPI received was taxable; however the BPI paid was to be added to the cost of the security on the basis of the judgment of the Supreme Court in the Vijaya Bank Ltd vs CIT (1991 187 ITR 541). The Bombay High Court in the American Express International Banking Corporation vs CIT (2002 258 ITR 601) case analysed the issue in great depth and after considering the Vijaya Bank case came to a conclusion that BPI was deductible revenue expenditure. The judgment in the American Express case is now being accepted and followed by all courts and tribunals, including by the Bombay High Court in the Citibank N.A. (264 ITR 18) case. The CBDT, in the present Instruction, has indicated that where a bank purchases securities under capital account at a price inclusive of accrued interest (that is, BPI), the entire purchase consideration is in the nature of capital outlay and, therefore, the BPI is not allowable as expenditure against income accruing on those securities. Scope for litigation This clarification of the CBDT will now open up a Pandora’s box and is likely to lead to prolonged litigation in the cases of banks that hold securities on capital account; it is also pertinent to note that the CBDT has not referred to the judgment in the American Express case. It may, however, be noted that the clarification is unlikely to impact banks that hold securities as stock-in-trade and not on capital account. The Instruction also refers to RBI guidelines dated October 16, 2000, which indicates that the investment portfolio of banks is required to be classified under three categories — held to maturity (HTM), available for sale (AFS) and held for trading (HFT) — and indicates the valuation norms prescribed by the RBI. The CBDT has indicated that the latest guidelines of the RBI may be referred to for allowing claims relating to depreciation in securities. By this Instruction, it appears that the CBDT intends to clarify that the depreciation on securities provided in the books of account of a bank, if in accordance with RBI guidelines, may be allowed as a deduction for income-tax purposes. It may also be noted that in Circular No. 665 dated October 5, 1993, the CBDT has directed that the AOs should determine on the facts and circumstances of each case as to whether any particular security constitutes stock-in-trade or investment taking into account the guidelines issued by the RBI in this regard from time to time. The Instruction also directs AOs to verify the claims of banks in respect of head-office expenditure in terms of Section 44C (for foreign banks having branches in India), claim for expenditure in respect of exempt income under Section 14A, deductibility of contribution to retiral funds (provident fund, superannuation fund, gratuity fund, etc.) in terms of Section 43B, deductibility of VRS expenditure under Section 35DDA, deductibility of provisions for expenditure under Section 37(1) and taxability of income on mercantile basis in terms of Section 145. The Instruction accordingly makes it clear that the CBDT wants to tighten norms in respect of assessment of banks. In the process, the CBDT has also given its iews/clarifications/directions on issues such as deduction under Section 36(1)(vii) vis-À-vis Section 36(1)(viia), BPI and valuation of securities. –
    http://www.thehindubusinessline.com

  • Ref. my earlier comment – in the opening of second para- in place of ‘public’ – to read ‘government’

  • Refer the recently reported judgment in Shivshahi Punarvasan Prakalp vs. UOI (Bombay High Court)

    In the view the High Court has taken, the COD’s approval is not necessary in income-tax matters even where the assessee is an undertaking of the Central Government or any State Government. If that is so, the PSBs ought not to have been rightly required to obtain COD’s approval in any income-tax dispute. That gives rise to an intriguing question: In how many tax cases, the PSBs , besides other government undertakings, have thus far been denied the right to dispute for want of COD’s approval and what is the potential loss unwittingly suffered by them on the basis of the erstwhile wrong premise.

    vswaminathan

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