Case Law Details
The facts emanating from the order of the AO and the submissions of the assessee is that the assessee is a Co-operative Bank and is engaged in banking business and the assessee was claiming deduction u/s 80P(2)(a)(i) up to AY 2006-07 @ 100%. It is submitted that the assessee has claimed the interest income amount of Rs 4,04,16,564/- as interest income from the NPA (Non-performing assets) but since the loans/principal amounts have become bad the assessee has neither received the loan amount nor the interest income. The assessee has treated the interest amount as “interest receivable” in the debit side of the balance sheet and as a liability under the head “overdue interest reserve account” in the credit side of the balance sheet. The AO has treated the interest income from the NP As as a normal business income on the ground that in the mercantile system of accounting the accrued income is to be treated as income of the assessee and accordingly, has made the addition of Rs. 4,04,16,564/- vide the order of the AO.
The assessee is in appeal’ against the order of the AO and it is submitted that the AO is not justified to make the addition as the loan/principal amount has become bad (NPA) and at the same time, the assessee has not received any interest income and as such no real income has accrued to the assessee. It is submitted that in the case of interest on NP As the party account is debited and the interest account is credited in the P&L account and since the interest is actually not received a reverse entry is passed at the year-end by which the P&L account is debited and the overdue interest account is credited. It is also submitted that the assessee has maintained the books of accounts on the NP A and its interest on the basis of the RBI guidelines and since the income has not been received by the assessee, the AO is not justified to treat the same as income of the assessee. It is also submitted that when the interest income finally recovered or received in future the same is accounted for and offered as income of the assessee in the relevant FY. It is also submitted that only the real income of the assessee may be taxed and not the notional income. The assessee also submitted that no interest would be said to have accrued to the assessee on the loans of doubtful recovery and the assessee also relied on various case laws some of which are as under:-
- CIT Vs Shoorji Vallabhdas & Co, 46 ITR 144 (SC) [1962]
- CIT Vs Vasisth Chay Vyapar Ltd, 330 ITR 440 (Delhi), 2011
- DIT Vs Brahmaputra Capital Financial Services Ltd, 335 ITR 182 (Delhi), 2011
- TRO Vs Custodian, 293 ITR 369 (Del)
- Barkha Investment & Trading Co P Ltd Vs CIT, 281 ITR 31 (Guj)
- CIT vs Nainital Bank Ltd. 309 ITR 335 (Uttarakhand) (7) CIT vs Elgi Finance Ltd. 293 ITR 357 (Mad)
- CIT Vs Motor Credit Co P Ltd, 127 ITR 572 (Mad) [1981]
- CIT Vs Coimbatore Lakshmi Inv. & Finance Co Ltd, 331 ITR 229 (Mad) [2011]
- UCO Bank Vs CIT, 237 ITR 889 (SC)[1999]
We further observe that the CIT(A) granted relief to the assessee with following observations and conclusion:-
“4.3 I have considered the order of the AO and the submissions of the assessee and I find considerable merit in the submission of the assessee that since the assessee has not actually received the income as the loan/principal amount itself has become bad and as such the AO is not justified to treat the notional interest as income of the assessee. A perusal of the case laws cited by the assessee also supports the case of the assessee that only the real income is taxable and not the hypothetical income in view of the real income theory as no real income is actually received by the assessee and the same view has been held by the Hon ‘ble Supreme Court in the case of CIT Vs Shoorji Vallabhdas & Co, 46 ITR 144 (SC) [1962] and the head note of the case reads as under :-
“Held, that the subsequent agreement had altered the rate of commission in such a way as to make the income which really accrued to the assessee different from what had been entered in the books of account. This was not a case of a gift by the assessee to the managed companies of a portion of income which ‘had already accrued, but an agreement to receive a lesser remuneration that what had been agreed upon. The assessee had in fact received only the lesser amount in spite of the entries in the account books, and this lesser amount alone was taxable.
Income-tax is a levy on income. Though the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt, yet the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a “hypothetical income”, which does not materialise . Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account.
Decision of the Bombay High Court in Commissioner of Income-tax v. Shoorji Vallabhdas & Co. [1959] 36 I.T.R. 25 affirmed.
Commissioner of Income-tax v. Chamanlal Mangaldas & Co. [1960] 39 I. T.R. 8 (S. C.) followed.”
4.4. It has also been held in the case of CIT Vs Motor Credit Co P Ltd, 127 ITR 572 (Mad) [1981] that only the real income is to be taxed and the head-note of the case reads as under :-
“The regular mode of accounting determines only the mode of computing the taxable income and the point of time at which the tax liability is attracted. It cannot determine or affect the range of taxable income or the ambit of taxation. Where no income has resulted it cannot be said that income has accrued merely on the ground that the assessee had been following the mercantile system of accounting. Even if the assessee makes a debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialised, there can be no liability to tax on a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account, but what should be considered is whether the income has really materialised or resulted to the assessee. The question whether real income has materialised to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to his system of accounting.”
4.5 After considering all the facts and circumstances of the case, I am of the view that there is considerable merit in the submission of the assessee regarding the notional interest income which has not been actually received by the assessee and as such the AO is not justified to make the addition on the basis of notional interest income only and accordingly, the addition made by the AO is deleted.”
During the argument, ld. Counsel of the assessee submitted various orders and judgments of the Tribunal including judgment of ITAT Delhi Bench ‘H’ in the case of assessee’s cooperative bank in I.T.A. No. 5549/D/12 dated 21.6.13 for Assessment Year 2009-10 in the case of DCIT vs Vaish Cooperative New Bank Ltd. wherein the issue of notional interest on non-performing assets (NPA) has been decided in favour of the assessee with following observations and conclusion:-
“5. Before the Ld. CIT (A) assessee submitted that Assessing Officer was not justified to make the addition in this case as the loan/Principal amount has become bad (NPA) and at the same time the assessee had not received any interest income and as such no real income has accrued to the assessee. The assessee further placed reliance upon accounting standards 9 in this regard. It was further submitted that no interest would be said to have accrued to the assessee as the loans thereof was of doubtful recovery. In this regard, assessee referred to various case laws as under :-
- “CIT Vs. Shoorji Vallabhdas & Co. 46 ITR 144 (SC) [1962]
- CIT Vs. Coimbatore Lakshmi Inv. & Finance Co. Ltd. 331 ITR 229 (Mad) [2011]
- CIT Vs. Motor Credit Co. P. Ltd. 127 ITR 572 (Mad) [1981]
- CIT Vs. Elgi Finance Ltd, 293 ITR 357 (Mad)
- CIT Vs. Nanital Bank Ltd, 309 ITR 335 (Uttarakhand)
- Barkha Investment & Trading Co. P.Ltd. Vs. CIT, 281 ITR 31(Guj)
- TRO Vs. Custodian, 293 ITR 369 (Del)
- DIT Vs. Brahmaputra Capital Financial Services Ltd, 335 ITR 182 (Delhi), 2011
- CIT Vs. Vasisth Chay Vyapar Ltd., 330 ITR 440(Delhi), 2011,
Upon consideration of the above, the Ld. CIT(A) opined that he was of the view that there was considerable merit in the submission of the assessee regarding the notional interest income which has not been actually received by the assessee and as such the Assessing Officer is not justified to make the addition on the basis of notional interest income only and accordingly, the addition made by the Assessing Officer was deleted.
Against the above order, revenue is in appeal before us. We have heard both the counsels and perused the records. We find that the interest in this case was due on non-performing assets (NPA). As per the RBI guideline in this regard, interest on NPAs is not to be recognized. Accounting standard 9 issued by the Institute of Chartered Accountant of India also provides that income is to be recognized only when there is some reasonable certainty about the receipt of the income. We, further, find that this view is also supported by the decisions, as mentioned above. We find that in the case of CIT Vs. Elgi Finance Ltd. 293 ITR 357, Hon ’ble Madras High Court has held that interest on nonperforming asset is not to be recognized in light of the RBI notification and accounting standard 9 issued by the Institute of Chartered Accountant of India.
In the light of aforesaid discussion and precedents. We do not find any infirmity in the order of Ld. CIT(A). Accordingly, we uphold the same.”
In view of above, at the very outset, we may point out that the AO wrongly mentioned that the guidelines of RBI and Circulars are not binding upon the income tax authorities as urban cooperative banks are bound to follow income recognition policy decided by the RBI and when RBI has made it clear that cooperative banks should not take to income account interest on performing assets on accrual basis, then it is not appropriate for the cooperative banks to recognise interest on non-performing assets as their income on national basis. Therefore, basis of the action of the AO is not sustainable and in accordance with the provisions of the Act. We further note that where no income has resulted in the hands of the assessee cooperative bank as interest on NPA, then the same cannot be held as income accrued to the assessee merely on the ground that the assessee had been following the mercantile system of accounting. We are unable to agree with the conclusion of the CIT(A) that if no income has materialised in the hands of the assessee as actual accrual of interest from NPA, then there can be no liability to tax on hypothetical income. It is not a hypothetical accrual income based on mercantile system of accounting followed by the assessee that has to be taken into account but the crux of the issue is that whether the income has really materialised or accrued to the assessee as interest on NPA. We are also in agreement with the observations of the CIT(A) that the question whether real income as materialised to the assessee has to be considered with reference to business and commercial reality of the situation in which the assessee has been placed and not with reference to his system of accounting.
On this issue, it is relevant to note that as per RBI Circular No. UBD.PCB .MC .3/09.14.000/2009-10 dated 1.7.2009, the income recognition policy from NPA has been set out as follows:-
“4.1 Income Recognition – Policy
4.1.1 The policy of income recognition has to be objective and based on the record of recovery. Income from non-performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received. Therefore, banks should not take to income account interest on non-performing assets on accrual basis.”
It is pertinent to mention that all cooperative banks including the assessee are bound to follow RBI Circular (supra) for recognition of income from NPA and in derivation therefrom may create serious problems for the violating bank. Hence, conclusion of the AO was not correct that RBI guidelines/Circulars are not binding on the income tax authorities. Per contra, when the assessee cooperative bank is following income recognition policy set out by the RBI, then it cannot be compelled to follow other method of recognition and income tax authorities have to consider this aspect before making any disallowance or addition in this regard.
