IN THE ITAT DELHI BENCH ‘A’
Deputy Commissioner of Income-tax
Bhartiya Samruddhi Finance Ltd.
IT Appeal Nos. 100 To 103 (Delhi) Of 2010
And 2308 & 5642 (Delhi) Of 2011
[Assessment Years 2004-05 To 2008-09]
Date of Pronouncement – November 23, 2012
A.D. Jain, Judicial Member
These are appeals filed by the department for Assessment Years 2004-05 to 2008-09. In ITA Nos.100 & 102/Del/2010 and in ITA Nos.2308 & 5642/Del/2011, the department has taken the common ground of appeal, which reads as under:-
“In the facts and circumstances of the case, the Ld. CIT(A) has erred in law and on facts by deleting addition of Rs. 14,97,811/- [Rs. 48,97,167/- in ITA No.102/Del/2010, Rs. 46,94,000/- in ITA No. 2308/Del/2011 & Rs. 15,36,328 in ITA No.5642/Del/2011] on account of de-recognized interest on accrual basis on Non-Performing assets (NPA) made by the A.O. ignoring that the assessee company has been regularly maintaining its accounts on mercantile system and was bound to offer interest de-recognised on accrual basis on NPA as income of the year as per the provision of Sec.145 of the IT Act.”
1.1 In ITA No. 101/Del/2010, the department has taken the following ground of appeal:-
“On the facts and in the circumstances of the case, the Ld. CIT(A) erred in law and on facts in deleting addition of Rs. 44,40,000/- on account of Provision for Doubtful debts for Non-Performing assets made by the A.O. ignoring that such provision are unascertained liabilities and contingent in nature and the assessee company failed to show that the liability in respect of expenditure was ascertained and had actually arisen and incurred in the relevant year.”
1.2 In ITA No.103/Del/2010, the department has taken both the above grounds as under:-
“1. In the facts and circumstances of the case, the Ld. CIT(A) has erred in law and on facts by deleting addition of Rs. 33,43,597/- on account of de-recognized interest on accrual basis on Non-Performing assets (NPA) made by the A.O. ignoring that the assessee company has been regularly maintaining its accounts on mercantile system and was bound to offer interest de-recognised on accrual basis on NPA as income of the year as per the provision of Sec.145 of the IT Act.
2. On the facts and in the circumstances of the case, the Ld. CIT(A) erred in law and on facts in deleting addition of Rs. 5706000/- on account of Provision for Doubtful debts for Non-Performing assets made by the A.O. ignoring that such provision are unascertained liabilities and contingent in nature and the assessee company failed to show that the liability in respect of expenditure was ascertained and had actually arisen and incurred in the relevant year.”
2. Apropos the issue relating to de-recognized interest, the facts, being common in all the appeals in which this issue has been raised, are being culled from ITA No.100/Del/2010.
3. The issue is as to whether the assessee is entitled to de-recognised interest on accrual basis on non-performing assets.
4. The Assessing Officer observed that as per the Notes on Accounts of the assessee, it had been mentioned that the interest on loans to rural producers was the net of rebates for on time repayment and interest de-recognised. The assessee was asked to show cause as to why the interest de-recognised be not added to the assessee’s income. In response, the assessee submitted, inter alia, that it was a Non-Banking Finance Company (NBFC) as per the directions of Reserve Bank of India and had to follow the directions of RBI; that as such, it had been following all the strict provisions of the RBI relating to Prudential Norms and Accounting and Audit Standards; that accordingly, the assessee company had been de-recognising the interest on the non-performing assets (NPAs); that as per the directions of the RBI, the company was not supposed to recognize the interest on NPAs; and that it was these directions which the assessee company had strictly followed. The Assessing Officer, however, did not find substance in the stand taken by the assessee. It was observed that the RBI Guidelines were prudential in nature and were not binding under the Income-tax Act; that the amount of interest undoubtedly represented the income of the assessee; and that even if the assessee’s contention to the effect that the interest was de-reognised by the RBI and was not included in the assessee’s income, was accepted, the assessee was duty bound to offer the same as income in the computation of income as per the provisions of the IT Act and the accrual system of accounting. It was in this manner that the Assessing Officer treated de-recognised interest as income of the assessee and added it back to the total income of the assessee.
5. The Ld. CIT(A) deleted the addition made by the Assessing Officer on account of de-recognised interest on accrual basis on NPAs. Against the said action of the Ld. CIT(A), the Ld. DR has argued before us that the Ld. CIT(A) has erred in deleting the addition correctly made on account of de-recognised interest on accrual basis on NPAs; that while doing so, the Ld. CIT(A) has gone wrong in ignoring the fact that the assessee company has been regularly maintaining its accounts on the mercantile system of accounting and that it was bound to offer interest de-recognised on accrual basis on NPAs, as it is income as per the provisions of Section 145 of the Act.
6. The ld. counsel for the assessee, on the other hand, has placed strong reliance on the impugned order, contending that the Ld. CIT(A) has correctly deleted the addition wrongly made; that as per the directions issued by the RBI, every company registered as an NBFC shall mandatorily follow certain guidelines, which include determination of NPAs, based on the age of the loans; that it is these mandatory directions issued by the RBI that the assessee company has followed to the word; that then, the assessee company was also acting under the Accounting Standards issued by the ICAI; that it is well settled that if the Accounting Standards as applicable to the method of valuation of closing stock are to be followed, the same should be applicable for income recognition on non-performing assets also, in the case of NBFCs like the assessee company; that it is undisputed that the directives issued by the RBI override all other laws; that it is the consistently followed accounting policy of the assessee company, in tune with the RBI requirements, that once the assets are identified as NPAs, interest recognition thereon is stopped; that this is so, because the direction of the RBI is to the effect that when the principal is not likely to be recovered, where a default had occurred, accounting interest was out of question; that the Prudential Norms and Directions of the RBI, concerning NBFCs lay down that the income from NPAs will not be recognized merely on the basis of accrual and since an asset becomes an NPA when it ceases to yield income, the income from the NPAs should be recognized only when actually received, i.e., on cash basis; that it is also well settled that even under the mercantile system of accounting, interest on NPAs does not accrue since an asset becomes non-performing when it ceases to yield income.
7. We have heard the parties on this issue and have examined the material on record with regard thereto. It is patent on record that the assessee company, incorporated under the Companies Act, 1956, is a registered Non-Banking Finance Company. It is engaged in the business of providing micro-finance services, i.e., providing mainly collateral free loans to the poor in the rural areas with a view to eradicate poverty in India, increase livelihood and employment opportunities in agricultural and non-farm sectors. The company was established in 1995. It secured a licence from the RBI u/s 45-I of the RBI Act, to carry on the business of non-banking finance, including micro-finance services. There exist Prudential Norms, issued by the RBI. The assessee, being a licensed NBFC, it had to follow the directives of the RBI. It was in accordance therewith, as also in accordance with the Accounting Standards issued by the ICAI, that the assessee de-recognised the interest on NPAs. Before the authorities below, the assessee filed the following documents:-
(i) Memorandum of Association and Articles of Association of the company
(ii) Certificate of Incorporation under the Companies Act.
(iii) Certificate of Registration u/s 45-I of the RBI Act, 1934.
8. The assessee’s system of accounting and procedures were also furnished. The books of account and other documents were also produced beside the audited financial statements and correspondence with the RBI. The shareholding pattern of the assessee company was also laid before the taxing authorities.
9. It is seen that as per the RBI directions, every company registered as an NBFC shall mandatorily follow certain accounting guidelines, including those pertaining to determination of NPAs based on the loans. According to these directions, regarding NPAs, the NBFCs are required to make certain provisions in such a way that the capital adequacy of the company is not eroded and so they remain healthy so as to meet the obligations to the banking sector. Further, the NBFCs are to de-recognise the interest accrued and accounted for as income on the NPAs, since the directions of the RBI are to the effect that income of NBFCs should not be over stated by them recognizing the interest on NPAs once identified. Thus, where the accrual basis of accounting for recognizing the income is being followed by NBFCs, the RBI directions are to the effect that income on the NPAs should be stopped from being accounted as income thereon and that it shall be accounted as income only as and when realized.
10. Further, Section 45-S of the RBI Act has made the aforesaid RBI directions mandatory, overriding all existing laws, leaving no choice with NBFCs like the assessee company.
11. Moreover, as also recognized in Uniflex Industries (P.) Ltd. v. ITO  15 SOT 246 (Luck.), Accounting Standard-II issued by the ICAI has been made mandatory in the case of companies. According to AS-II(5), inventories should be valued at “lower of cost and net realizable value”, leaving no choice in the matter with the assessee company.
12. Apropos interest de-recognition of NPAs, in accordance with the RBI directions, once the NPAs are identified as such, interest recognition thereon is stopped. This is so, for when the principal is not likely to be recovered, where a default has occurred, the question of accounting interest is otiose. It is in accordance with this that the interest has been stopped. Then, as per the Accounting Standards, any income accruing on assets already matured, is to be stopped. Further, the RBI directions also state that income from NPAs will not be recognized merely on the basis of accrual and it should be recognized only when actually received, i.e., on cash basis.
13. Further still, the regular mode of accounting only determines the mode of computing, taxable income and the point of time at which the tax liability gets attracted. Where no income has resulted, no income can be said to have accrued, just because the mercantile system of accounting is being followed. In the following decisions, it has been held that interest income from NPAs should be recognised only on actual receipt:-
(i) CIT v. Motor Credit Co. (P.) Ltd.  127 ITR 572
(ii) Overseas Sanmar Finance Ltd. v. Jt. CIT  86 ITD 602 (Chennai)
(iii) CIT v. India Equipment Leasing Co. Ltd.  293 ITR 350 (Mad.)
(iv) CIT v. Elgi Finance Ltd.,  293 ITR 357 (Mad.)
(v) Ted Co Investment and Financial Services (P.) Ltd. v. Dy. CIT  87 ITD 298 (Delhi)
(vi) T.C.I. Finance Ltd. v. Asst. CIT  91 ITD 573 (Hyd.)
(vii) United Bank of India v. Dy. CIT  68 ITD 332 (Cal.)
14. Not only this, CBDT Circular No. 491 dated 30.06.1987 provides that interest on sticky advances is to be allowed if the assessee is following the mercantile system of accounting and has changed the method of accounting to cash basis for recognizing the interest on sticky loans. Though this Circular is applicable to State Finance Corporations, it applies equally to NBFCs too.
15. All the above facts were duly taken into consideration by the Ld. CIT(A) while deciding this issue in favor of the assessee.
16. In CIT v. Vasisth Chay Vyapar Ltd.  330 ITR 440and in DIT v. Brahmaputra Capital Finance Ltd.  335 ITR 182 also, interest income from NPAs has been held to be recognizable only on actual receipt.
17. In view of the above, we do not find any error in the order of the Ld. CIT(A) regarding this issue and we hereby uphold the same. As such, the grievance of the department with regard to this issue is rejected.
18. So far as regards the issue of provision for doubtful debts, this matter, it is seen, now stands concluded against the assessee and in favour of the department by the Hon’ble Supreme Court in Southern Technologies Ltd. v. Jt. CIT  320 ITR 577, holding that provision for non-performing assets debited to the Profit & Loss Account by an NBFC, made under the RBI Prudential Norms, can be treated as income; and that it is not “expense” deductible u/s 36(1)(vii) or (viia)of the IT Act. No decision to the contrary has been relied on before us by the assessee.
19. Accordingly, the grievance of the department in this regard is justified and is accepted as such. The order of the Ld. CIT(A), to this extent is set aside and that of the Assessing Officer is revived.
20. In the result, ITA Nos. 100/Del/2010, 102/Del/2010, 2308/Del/2011 & 5642/Del/2011 are dismissed; ITA No. 101/Del/2010 is allowed; and ITA No. 103/Del/2010 is partly allowed.