HIGH COURT OF MADRAS
Commissioner of Income-tax
Sakthi Finance Ltd.
T.C. (A) NOS. 282 AND 283 OF 2007
FEBRUARY 12, 2013
R. Banumathi, J.
The question pertains to whether the accrued interest on non- performing assets (NPA) is assessable to income-tax. The Revenue has preferred these appeals as against the Orders dated 15.09.2006 made in INT.T.A.Nos.4/Mds/2006 and 5/Mds/2006 respectively in respect of the assessment years 1999-2000 and 2000-2001. The appeals were admitted on the following substantial questions of law:
“1. Whether on the facts and in the circumstances of the case, the Income Tax Tribunal is right in law in deleting the interest accrued on non performing assets from the computation of the taxable income for the assessment year 1999-2000 and 2000-2001?
2. Whether on the facts and circumstances of the case, the Tribunal was right in law in not considering the accrued interest on non performing assets under the Interest Tax Act 1999-2000 and 2000-2001?
2. The assessee-Sakthi Finance Limited is a Non-Banking Financial Company. For the assessment years 1999-2000 and 2000-2001, the Assessing Officer has added accrued interest on NPA accounting to Rs. 1,80,34,379/- and Rs. 56,09,260/ for the two years. The assessee preferred appeals before C.I.T. (Appeals). In the case of CIT v. Elgi Finance Ltd. 293 ITR 357, the Madras High Court has held no interest could be said to have accrued on loans doubtful of recovery which were classified as NPA. Following the said decision in Elgi Finance Ltd. CIT (Appeals) allowed the appeals holding that the accrued interest on NPA is not assessable to income-tax. In the appeal preferred by the revenue before the Tribunal, following its own decision in Elgi Finance Ltd. v. Addl. CIT Special Range I, Coimbatore in I.T.A.No.358, 359, 360 and 361 (Mds) of 2002, Tribunal held that no addition could be made in the hands of the assessee Non-Banking Financial Company (NBFC) in respect of unrealised accrued interest when the loan was classified as NPA.
3. Learned counsel for the revenue placing reliance upon the decision of the Supreme Court in Southern Technologies Ltd. v. Jt. CIT 320 ITR 577, submitted that insofar as liability of income-tax is concerned, the same was governed by the Income-tax Act and merely because for accounting purpose, the respondent/assessee was to follow RBI guidelines it would not mean that the assessee was not liable to show the accrued interest income when it had accrued to the assessee under the mercantile system and exigible to tax under the Act. Drawing our attention to the assessment orders in which the method of accounting of the assessee is stated as “Mercantile”, Mr. Balaji, the learned counsel for revenue submitted that when the assessee was following ‘mercantile method’ of accounting, the case of the assessee was to be dealt with for the purpose of taxability as per the provisions of the Act and not the RBI Act, which was the accounting method, which the assessee NBFC was required to follow.
4. In paragraph No.27 of the Southern Technologies Ltd. (supra), the Hon’ble Supreme Court elaborated upon the three deviations between RBI Directions 1998 and Companies Act. Relying upon the decision of Southern Technologies Ltd. (supra) and the deviations pointed out by the Hon’ble Supreme Court, the learned counsel for the revenue submitted that the Hon’ble Supreme Court emphasised that the RBI Directions 1998 has nothing to do with the accounting treatment or taxability of income under the Income-tax Act and the two viz., the Income-tax Act and RBI Directions 1988 operate in different fields. He would further submit that as per the decision in Southern Technologies, so far as the liability of income-tax is concerned, the same was governed by Income-tax Act and RBI Directions 1998 has nothing to do with the computation or taxability of the provisions for “accrued interest” for NPA under the Income-tax Act.
5. Per contra, Mr. VikramVijayaraghavan, learned counsel for assessee submitted that in the case of Southern Technologies Ltd. (supra) the Hon’ble Supreme Court clearly recognised the theory of “real income” and held that notwithstanding that the assessee may be following the mercantile system of accounting and the assessee could only be taxed on “real income” and not on accrued interest, which is a hypothetical income.
6. Learned counsel for the assessee submitted that referring to the decision of the Supreme Court in Southern Technologies Ltd. (supra), the Delhi High Court in CIT v. VasisthChayVyapar Ltd. 330 ITR 440held that where the interest was not received on NPA, the same could not be treated to have accrued in favour of the assessee or the real income in the hands of the assessee.
7. The controversy arising for consideration is, whether non-recognition of “interest income” on NPAs by the assessee following RBI guidelines would by itself constitute a valid ground for not recognising the said income on the basis of its non-accrual, the adopted method of accounting, being admittedly ‘mercantile.’
8. In the present case, the assessee Company is Non-Banking Financial Company. The assessee objected to the inclusion of interest on NPA that it is not assessable to income. The assessee pleaded that in the earlier assessment years they got a relief on the same issue based on the judgment of the Tribunal in the case of Elgi Finance Ltd. (supra), and in view of the Judgment it was argued that the additions are not proper. Commissioner of Income-tax (Appeals) held that the accrued interest on NPA is not assessable to income-tax and following the judgment of the Tribunal allowed the appeals for the assessment years 1999-2000 and 2000-2001.
9. In Elgi Finance Ltd. (supra), almost identical controversy was considered. The Assessing Officer proposed to bring the accrued interest as income of assessee relating to the assessment year. The assessee explained that as it was a NBFC, those assets were to be treated as NPAs in terms of the guidelines issued by RBI and the income pertaining thereto was not to be considered as income. The Assessing Officer held that since the Assessee Company was following the mercantile system of accounting, the Assessing Officer held that both income as well as expenditure had to be accounted on accrual basis. The appeal of the assessee was dismissed by Commissioner of Income-tax (Appeals). On further appeal by the assessee, the Tribunal was of the view that the lower authorities erred in treating the interest on NPAs as income of assessee Company for the relevant assessment year and ordered to delete the said interest from the computation of the taxable income and allowed the appeals filed by the assessee. On those facts, this Court held that no interest could be said to have accrued on loans doubtful of recovery, which were classified as NPAs. This Court further held that the interest from such NPAs would be taxed in the appropriate assessment year on the basis of ‘actual receipt’.
10. The decision in Elgi Finance is prior to Southern Technologies Limited. In the case of Southern Technologies Ltd. (supra) constitutional validity of Section 43D was questioned by Non Banking Financial Institutions, who are not entitled to deductions on account of Non Performing Assets though they are also engaged in the same activity of lending moneys and the Hon’ble Supreme Court held that Section 43D is constitutionally valid. In the case of Southern Technologies Ltd. (supra), the Hon’ble Apex Court was seized with the issue of provision for bad and doubtful debts in respect of NPA accounts and the dispute before the Apex Court centered around the deductibility of provision for Non Performing Assets.
11. Elaborating upon the deviations between RBI Directions 1998 and Companies Act, the Hon’ble Supreme Court in the case of Southern Technologies Ltd., held as under:
“Deviations between the RBI Directions, 1998 and the Companies Act 27. Broadly, there are three deviations:
(i) in the matter of presentation of financial statements under Schedule VI to the Companies Act;
(ii) in not recognising the ‘income’ under the mercantile system of accounting and its insistence to follow cash system with respect to assets classified as NPA as per its norms;
(iii) in creating a provision for all NPAs summarily as against creating a provision only when the debt is doubtful of recovery under the norms of the accounting standards issued by the Institute of Chartered Accountants of India.
28. These deviations prevail over certain provisions of the Companies Act, 1956 to protect the depositors in the context of income recognition and presentation of the assets and provisions created against them.
29. Thus, the P&L account prepared by NBFC in terms of the RBI Directions, 1998 does not recognise ‘income from NPA’ and, therefore, directs a provision to be made in that regard and hence an ‘add back’. It is important to note that ‘add back’ is there only in the case of provisions.
30. As stated above, the Companies Act allows an NBFC to adjust a provision for possible diminution in the value of assets or provision for doubtful debts against the assets and only the net figure is allowed to be shown in the balance sheet, as a matter of disclosure. However, the said RBI Directions, 1998 mandate all NBFCs to show the said provisions separately on the liability side of balance sheet i.e. under the head ‘current liabilities and provisions’. The purpose of the said deviation is to inform the user of the balance sheet the particulars concerning quantum and quality of the diminution in the value of investment and particulars of doubtful and sub-standard assets. Similarly, the 1998 Directions do not recognise the ‘income’ under the mercantile system and insist that NBFCs should follow cash system in regard to such incomes.
31. Before concluding on this point, we need to emphasise that the 1998 Directions have nothing to do with the accounting treatment or taxability of ‘income’ under the IT Act. The two viz. the IT Act and the 1998 Directions operate in different fields.”
12. In VasisthChayVyapar Ltd. (supra), the Delhi High Court considered the case of Southern Technologies Ltd. (supra) and held that Supreme Court made a distinction with regard to “income recognition” and that the Supreme Court approved the “real income” theory which is engrained in the Prudential Norms for recognition of revenue by NBFC. The Delhi High Court held as under:
“…. After analyzing the provisions of the RBI Act, their Lordships of the apex court observed that in so far as the permissible deductions or exclusions under the Act are concerned, the same are admissible only if such deductions/exclusions satisfy the relevant conditions stipulated therefor under the Act. To that extent, it was observed that the Prudential Norms do not override the provisions of the Act. However, the apex court made a distinction with regard to “income recognition” and held that income had to be recognized in terms of the Prudential Norms, even though the same deviated from the mercantile system of accounting and/or section 145 of the Income-tax Act. It can be said, therefore, that the apex court approved the real income theory which is engrained in the Prudential Norms for recognition of revenue by NBFC.”
13. The Delhi High Court considered the decision of Supreme Court in Southern Technologies Ltd. (supra) and held that the decision of the Hon’ble Supreme Court in case of Southern Technologies Ltd. (supra), apply only to provisioning norms ‘against NPA accounts’. The Delhi High Court held that Southern Technologies Limited did not apply to the income recognition norms provided by RBI but only to the prudential norms (against accounts).
14. True, as observed in the case of VasisthChayVyapar Ltd. (supra) Hon’ble Apex Court was seized with the issue of provision for bad and doubtful debts in respect of NPA accounts and not income not brought on books on the basis of non-accrual. But the Delhi High Court had taken the view that Southern Technologies Ltd. case (supra) did not apply to the income recognition norms provided by RBI. We are of the view that by a careful reading of the decision of Southern Technologies Ltd., the Hon’ble Supreme Court also dealt with the aspect i.e., income recognition norms as spelt out by the RBI as well.
15. In case of Southern Technologies Ltd., the Hon’ble Supreme Court dealt with the income recognition norms as spelt out by the RBI as well and observed that the RBI’s Directions and the Income-tax Act operate in different fields. We may demonstrate this by extracting the relevant paragraphs from the decision of Southern Technologies Ltd., which read as under:
“31. Before concluding on this point, we need to emphasise that the 1998 Directions have nothing to do with the accounting treatment or taxability of ‘income’ under the Income-tax Act. The two viz. the Income-tax Act and the 1998 Directions operate in different fields. As stated above, under the mercantile system of accounting, interest/hire charges income accrues with time. In such cases, interest is charged and debited to the account of the borrower as ‘income’ is recognised under the accrual system. However, it is not so recognised under the 1998 Directions and, therefore, in the matter of its presentation under the said Directions, there would be an add back but not under the Income-tax Act necessarily. It is important to note that collectibility is different from accrual. Hence, in each case, the assessee has to prove, as has happened in this case with regard to the sum of Rs. 20,34,605, that interest is not recognised or taken into account due to uncertainty in collection of the income. It is for the Assessing Officer to accept the claim of the assessee under the Income-tax Act or not to accept it in which case there will be add back even under real income theory as explained hereinbelow.
33. Prior to the RBI Directions, 1998, advances were stated net of provisions for NPAs/bad and doubtful debts. They were shown at net figure (advances less provisions for NPAs) and the amount of provision for NPA was shown in the notes to the accounts only. Such presentation of NPA provision warranted disclosure. Therefore, Paragraph 9(1) of the RBI Directions, 1998 stipulates that every NBFC shall separately disclose in its balance-sheet the provision for NPAs without netting them from the income or against the value of assets. That, the provision for NPA should be shown separately on the ‘liabilities side’ of the balance-sheet under the head ‘current liabilities and provisions’ and not as a deduction from ‘sundry debtors/advances’. Therefore, the RBI has taken a position as a matter of disclosure, with which we agree, that if an NBFC deducts a provision for NPA from ‘sundry debtors/loans and advances’, it would amount to netting from the value of assets which would constitute breach of Paragraph 9 of the RBI Directions, 1998. Consequently, NPA provisions should be presented on the ‘liabilities side’ of the balance sheet under the head ‘current liabilities and provisions’ as a disclosure norm and not as accounting or computation of income norm under the Income-tax Act. At this stage, we may clarify that the entire thrust of the RBI Directions, 1998 is on presentation of NPA provision in the balance-sheet of an NBFC. Presentation/disclosure is different from computation/taxability of the provision for NPA. The nature of expenditure under the Income-tax Act cannot be conclusively determined by the manner in which accounts are presented in terms of the 1998 Directions. There are cases where on the facts courts have taken the view that the so-called provision is in effect a write-off. Therefore, in our view, the RBI Directions, 1998, though deviate from the accounting practice as provided in the Companies Act, do not override the provisions of the Income-tax Act. Some companies, for example, treat write-offs or expenses or liabilities as contingent liabilities. For example, there are companies which do not recognise mark-to-market loss on its derivative contracts either by creating reserve as suggested by ICAI or by charging the same to the profit and loss account in terms of Accounting Standards. Consequently, their profits and reserves and surplus of the year are projected on the higher side. Consequently, such losses are not accounted in the books, at the highest, they are merely disclosed as contingent liability in the notes to accounts. The point which we would like to make is whether such losses are contingent or actual cannot be decided only on the basis of presentation. Such presentation will not bind the authority under the Income-tax Act. Ultimately, the nature of transaction has to be examined. In each case, the authority has to examine the nature of expense/loss. Such examination and finding thereon will not depend upon presentation of expense/loss in the financial statements of the NBFC in terms of the 1998 Directions. Therefore, in our view, the RBI Directions, 1998 and the Income-tax Act operate in different fields.
34. The question still remains as to what is the nature of ‘provision for NPA’ in terms of the RBI Directions, 1998. In our view, provision for NPA in terms of the RBI Directions, 1998 does not constitute expense on the basis of which deduction could be claimed by NBFC under Section 36(1)(vii). Provision for NPAs is an expense for presentation under the 1998 Directions and in that sense it is notional. For claiming deduction under the Income-tax Act, one has to go by the facts of the case (including the nature of transaction), as stated above. One must keep in mind another aspect. Reduction in NPA takes place in two ways, namely, by recoveries and by write-off. However, by making a provision for NPA, there will be no reduction in NPA. Similarly, a write-off is also of two types, namely, a regular write-off and a prudential write-off. (See Advanced Accounts by Shukla, Grewal and Gupta, Ch. 26, p. 26.50.) If one keeps these concepts in mind, it is very clear that the RBI Directions, 1998 are merely prudential norms. They can also be called disclosure norms or norms regarding presentation of NPA provisions in the balance-sheet. They do not touch upon the nature of the expense to be decided by the Assessing Officer in the assessment proceedings.
Applicability of Section 145
40. At the outset, we may state that in essence the RBI Directions, 1998 are prudential/provisioning norms issued by RBI under Chapter III-B of the RBI Act, 1934. These norms deal essentially with income recognition. They force the NBFCs to disclose the amount of NPA in their financial accounts. They force the NBFCs to reflect ‘true and correct’ profits. By virtue of Section 45-Q, an overriding effect is given to the Directions, 1998 vis-a-vis ‘income recognition’ principles in the Companies Act, 1956. These Directions constitute a code by itself. However, these Directions, 1998 and the Income-tax Act operate in different areas. These Directions, 1998 have nothing to do with computation of taxable income. These Directions cannot overrule the ‘permissible deductions’ or ‘their exclusion’ under the Income-tax Act. The inconsistency between these Directions and the Companies Act is only in the matter of income recognition and presentation of financial statements. The accounting policies adopted by an NBFC cannot determine the taxable income. It is well settled that the accounting policies followed by a company can be changed unless the Assessing Officer comes to the conclusion that such change would result in understatement of profits. However, here is the case where the Assessing Officer has to follow the RBI Directions, 1998 in view of Section 45-Q of the RBI Act. Hence, as far as income recognition is concerned, Section 145 of the Income-tax Act has no role to play in the present dispute.”
16. In Paragraphs 31 and 34, the Hon’ble Supreme Court in no uncertain terms held that the collectibility of interest is different from accrual and in each and every case, the assessee has to prove that the income interest is not recognised or not taken into account due to uncertainty in collection of the income. It is for the Assessing Officer to accept the claim of the assessee under the Income-tax Act or not to accept. In case of Southern Technologies Ltd., the Assessing Officer accepted the assessee’s case towards non-recognition of interest for Rs.20.34 lakhs as would be apparent from a reading of Paragraph No.31 of the Judgment of the Hon’ble Supreme Court in case of Southern Technologies Ltd. By a careful reading of the case of Southern Technologies Ltd., we are of the view that the assessee has to prove in each case that interest not recognised or not taken into account was in fact due to uncertainty in collection of interest and it is for the Assessing Officer to examine facts of each individual case.
17. No doubt, the learned counsel for the assessee also relied on an unreported decision of this Court made in T.C.(A) Nos.282 to 286 of 2005 dated 6.7.2012 in support of his submission that interest accrued on non-performing assets is not chargeable to tax. In that case, the Hon’ble Division Bench rejected the case of the Revenue therein only by following the decision of Elgi Finance Limited as well as Harita Finance Limited. In fact, the subsequent decision of the Hon’ble Supreme Court made in the case of Southern Technologies Limited was not placed before the Division Bench. Moreover, in the said judgment, it was pointed out that the Revenue had not placed the material to show the nature of the transaction as one not being a Hire Purchase transaction. Therefore, the said decision of the Division Bench based on the factual findings so rendered, cannot be relied on by the assessee, more particularly, when the decision of the Hon’ble Supreme Court made in the case of Southern Technologies Limited was not at all placed before it. At any event, it is also pointed out that in the aid decision that the interest from such non-performing assets would be taxed in the appropriate assessment years on the basis of actual receipt and the issue of interest on non-performing assets could not be included in the assessment of the assessee till such accrual arose. Therefore, the said decision is also distinguishable and cannot be relied on by the assessee, in the light of the decision of the Hon’ble Apex Court in the case of Southern Technologies Limited.
18. Mere characterisation of an account as a NPA would not by itself be sufficient to say that there is uncertainty as regards realizability of income or interest income thereon. Accrual of interest is a matter of fact to be decided separately for each case on the basis of examination of the facts and circumstances. The same would require an assessment of the relevant facts and circumstances of each case. Only by assessment of facts and circumstances, the Authority could arrive at a decision whether there is uncertainity of the interest accrued on NPA. Only when there is uncertainity of realizability of income or interest income then it is not chargeable to tax. The system of accounting followed only recognises it bringing the income to books. The adopted accounting policy i.e., recognising income on NPA accounts only subject to realisation does not serve as a standard category.
19. In the present case, Assessing Officer has not recorded findings whether there is any uncertainty in collection of income. There is nothing to indicate that the “interest income” is non-recoverable. Individual ledger accounts of the borrower are to be examined. We are of the view that the Commissioner of Income-tax (Appeals) and the Tribunal had not considered the matter in the light of the decision of the Hon’ble Supreme Court in the case of Southern Technologies Ltd. We are of the view that the matter has to be considered in the light of the observations in case of Southern Technologies Ltd.
20. For the fore-going reasons, the Orders of the Tribunal are set aside and the matters are remitted back to the Assessing Officer for consideration of the matter afresh in the light of law laid down by the Supreme Court in Southern Technologies Ltd.’s case (supra) and above observation and pass orders.