Section 43D of the Act provides that income by way of interest in relation to bad and doubtful debts of a public financial institution or a scheduled bank or a cooperative bank or a state financial corporation or a state industrial investment corporation or a housing finance company is chargeable to tax in the previous year in which it is credited to the profit and loss account or, as the case may be, in which it is actually received.
The reason for introduction of section 43D in the Act, was that interest from bad and doubtful debts in the case of banks and financial institutions is difficult to recover and taxing such income on accrual basis reduces the liquidity of the bank without actual generation of income. Therefore, with a view to improve the viability of banks and financial institutions, the provisions of section 43D were introduced w.e.f. AY 1992-93.
Subsequently with a view to boost the viability of housing finance companies and to provide a boost to the housing sector, w.e.f. AY 2000-01, the benefit of the said provision was also extended to housing finance companies (a category of NBFCs) which are regulated by the NationalHousing Bank.
Further, w.e.f. AY 2018-19, to provide a level playing field to co-operative banks, the provisions of section 43D have recently been rationalised to extend the benefit of the said provisions to co-operative banks as well.
While NBFCs (other than housing finance companies which are already covered by the provisions of section 43D) have not been specifically covered by the aforesaid provisions, various judicial precedents4 have held that interest income on NPA’s under the provisions of the Act should be chargeable to tax only on receipt basis following the principle of real income. However, in absence of specific provisions under the Act, this matter has constantly been a subject matter of litigation.
Impact of Income Computation and Disclosure Standards (‘ICDS’) on taxation of Interest on NPAs
The Central Board of Direct Tax (‘CBDT’) has recently notified the Income Computation and Disclosure Standards (‘ICDS’) which are effective from AY 2017-
18. As per ICDS IV on Revenue Recognition, interest income shall be recognised on time proportionate basis i.e. on accrual basis.
This has been further clarified by the CBDT in its recent FAQs issued on 23 March 2017, which provides clarification on various aspects of applicability of ICDS. As per Question 13 of the FAQ, it has been clarified that interest accrues on time basis.
Further, as per Question 2 of the FAQ, CBDT has also clarified that provisions of ICDS shall prevail over past judicial precedents (thus overriding the real income principle laid down by various judicial precedents).However, recently it has been held by the Hon’ ble Delhi HC in the case of Chamber of Tax Consultants v. Union of India, dated 8.11.2017 that, inter alia, ICDS cannot supercede past judicial decisions. In view of the above CBDT clarifications, it may be challenging for NBFCs (other than housing finance companies) to adopt the position of taxing interest on NPA on receipt basis, severely impacting their cash flows and liquidity.
Like Banks even NBFCs are regulated by Reserve Bank of India (‘RBI’) and are mandated to follow RBI guidelines including on the prudential norms. As per RBI circular on NBFC (Deposit Accepting or Holding) Prudential Norms, Banks as well as NBFCs are required to create provision for NPAs. Further, as per the prudential norms, Banks as well as NBFCs shall recognise interest income on NPA only when it is actually realised. However, despite these similarities between a Bank and a NBFC, there is a distinction in the applicability of various tax provisions which puts NBFC s in a disadvantageous position vis-à-vis other financial institutions including Banks. Thus, the need for a uniform practice and level playing field in terms of tax treatment for NBFCs is indispensable.
In this regard, as mentioned above, in accordance with the directions issued by the RBI, similar to other financial institutions, NBFCs also follow prudential norms and are required to create provision for NPAs and defer income in respect of their non-performing accounts.
Considering the fact that similar to Banks, NBFCs are also engaged in financial lending to different sectors of the society, the Finance Act 2016, has expanded the scope of section 36(1)(viia) of the Act, by providing deduction to the extent of 5% of total income in respect of provision for bad and doubtful debts to NBFCs.
However, in absence of specific coverage of NBFCs (other than housing finance companies which are already covered by the provisions of section 43D) in section 43D and in light of the ICDS provisions, NBFCs would be required to recognise income on such NPAs for tax purposes on an accrual basis, resulting in levy of tax on income which may not be realised at all. This would severely impact the liquidity of NBFCs in terms of cash flow pay-outs, impacts their profitability and also has a consequent impact on their cost of operations.
Given the same, it is appropriate in all fairness that the provisions of section 43D which recognises the principle of taxing interest income on NPAs on receipt basis to certain banks and financial institutions, also be extended to NBFCs (other than housing finance companies which are already covered by the provisions of section 43D).
Amendment to section 43D
In light of the above, an amendment should be made to section 43D of the Act, to extend the benefit of section 43D to “Non-Banking Financial Company” (other than housing finance companies which are already covered by the provisions of section 43D), whereby interest income on nonperforming assets should be taxed only on receipt basis.
Amendment to Rule 6EA of Income-tax Rules (‘the Rules’)
Section 43D refers to the income by way of interest in relation to such category of bad and doubtful debts as may be prescribed in Rule 6EA of the Rules having regard to guidelines issued by RBI in relation to such debts. Accordingly, consequential amendment should also be made in Rule 6EA of Rules, which provides special provision regarding interest on bad and doubtful debts of banks and financial institutions, to include the “Non-Banking Financial Company” as well.
Amendment to section 43B
Consequential amendment should also be made in section 43B of the Act which provides a list of deductions which are allowed to the payer on actual payment basis. As represented above, given that interest income on NPA for
“Non-Banking Financial Company” should be taxed on receipt basis, deduction to the payer of interest on NPA to “NonBanking Financial Company” should be allowed on actual payment basis