Taxability of Interest on sick loans, accrued but not recognised as per AS – 9

ITAT COCHIN BENCH

Kerala State Industrial Products Trading Corpn. Ltd.

V/s.

Assistant Commissioner of Income-tax,

IT Appeal NOS. 256 & 257 (COCH.) of 2009

[ASSESSMENT YEARS 2003-04 & 2004-05]

JUNE 8, 2012

ORDER

B.R. Baskaran, Accountant Member

The appeals of the assessee are directed against the orders passed by the Ld. CIT(A)-I, Trivandrum and they relate to the assessment years 2003-04 & 2004-05.

2. In both the years, the assessee is assailing the decision of the Ld. CIT(A) in confirming the addition of Rs. 34,65,000/- relating to the estimated accrued interest on certain loans advanced by the assessee to some other Kerala Government industrial undertakings on the direction of the State Government of Kerala.

3. The facts relating to the issue are stated in brief. The assessee-company is wholly owned by the Government of Kerala. The assessee is engaged in the business of marketing of products manufactured by M/s. Travancore Titanium Products Ltd. On the direction of Government of Kerala, the assessee advanced money to various other Government of Kerala undertakings aggregating to Rs. 2,20,50,000/-. Since the said advances have become sick, the assessee did not provide for interest income from such advances. However, the Assessing Officer took the view that the interest accrued on such advances have to be accounted, as the assessee is following the mercantile system of accounting. Accordingly, he estimated the interest income on such advances at Rs. 34,65,000/- and added it in both the years under consideration. Before the Assessing Officer, the assessee placed reliance on the Circulars issued by the Reserve Bank of India with regard to non-performing assets of banking institutions in support of its claim of non-accounting of interest income. However, the Assessing Officer took the view that the said Circulars are applicable only to the commercial banks and hence the assessee cannot take support from them. The addition made by the Assessing Officer in both the years was confirmed by the Ld. CIT(A). Hence, the assessee is in appeal before us.

4. We have heard the rival contentions and perused the record. The details of loans given to the undertakings owned by Government of Kerala are furnished by the assessee in its written submissions and the same is extracted below:-

5. In the written submissions filed by the assessee, it is stated as under:-

“The only issue involved in these appeals is whether Commissioner of Income-tax (Appeals) Thiruvananthapuram was in order in confirming the assessment to income of notional interest of Rs. 34,65,000/- levied in the assessment of the above years on certain loans given by your appellant aggregating to Rs. 2,20,50,000/- to seven other public sector undertakings, wholly owned by the Govt. of Kerala, which had become sick and non-functional as on 31-03-2002. As on date, the names of the above loanee companies have been struck off from the register of the Registrar of Companies, Kerala (four companies have ceased to exist) and three are under liquidation under the supervision of the Court on account of extremely critical financial position. The loans have been disbursed in the previous years as per the orders of Govt. of Kerala and the details of the loans alongwith the interest debited in the earlier years upto 31-03-2002 aggregating to Rs. 52,09,365/- also pending recovery as on date carried forward in the accounts under the head Interest Receivable under Loans & Advances is given in the annexure attached. The reference of the Govt. Orders sanctioning the loans indicating the terms for levy of interest is also given in the above annexure enclosing copies of Govt. orders referred to therein. It may be noted that in the case of loans given to Keltron Projectors Ltd., and Keltron Sidkel Televisions Ltd., Government order is silent about interest and hence there is no mandate to charge interest. It is submitted that no interest income was recognised on these loans during the A.Ys. 2003-04 and 2004-05 as the loans had turned out to be irrecoverable and bad and the date on account of the critical financial position of the above said companies. The fact that the above said companies had become sick and non-functional has also been reported in the notes to accounts and Auditor’s Report for the years ended 31-03-2003 and 31-03-2004. Copies of the Notes to Accounts and the Auditor’s Report for the years ended 31.3.2003 and 31.3.2004 are annexed hereto for the perusal of the Hon’ble Bench. From the Notes to accounts and the Auditor’s Report, it could be noted that the Board of Directors of the company has taken a conscious decision not to charge interest on these loans during the above assessment years considering that the loan had become irrecoverable and bad.

2. The case of the appellant is that the loans had become totally bad and irrecoverable and hence there is no accrual of interest income on such bad/irrecoverable loans on facts of the case. It has been stated in page 4 of the appellate order of the learned Commissioner of Income Tax(Appeals) that “it was only when the loanee companies’ financial position became bad and recovery became doubtful that the decision to treat the asset as non- performing has been taken at company’s level and as such there is no direction from the Govt. of Kerala to that respect”. This is clear finding of fact by the learned Commissioner of Income Tax(Appeals), that the loans have become bad and irrecoverable.

3. Your appellant may draw the kind attention of the Hon. Bench to the fact that four loanee companies have been struck off from the Register of the Registrar of Companies and remaining three companies are under liquidation. The following loanee companies have been struck off from the Register of Registrar of Companies u/s. 560 of the Companies Act, 1956 and hence these companies have ceased to exist as on date.

 (a)  Kerala Soaps and Oils Ltd.

 (b)  Scooters Kerala Ltd.

 (c)  Metropolitan Engineering Co. Ltd.

 (d)  Travancore Plywood Industries Ltd.

The other loanee companies as detailed below are presently under liquidation under supervision of the Court or dormat and the financial position of these companies are reported to be extremely precarious as their liabilities have exceeded their assets by significant amounts.

(a)  Keltron Counters Ltd.

(b)  Keltron Projectors Ltd.

(c)  Keltron Sidkel Televisions Ltd. (which has been subsequently renamed as Sidkel Televisions Ltd.) (Dormat)

The copies of Company Master Details downloaded from the website of Ministry of Corporate Affairs, New Delhi (MCA) are annexed hereto to prove/substantiate the above submission.

4. Since the loanee companies have been either struck off and ceased to exist or are under liquidation owing to very critical financial position, there is no accrual of income on such bad/irrecoverable loans on the facts of the case.

Your appellant may also submit that the name of the appellant company has also been struck off from the Register of ROC as per communication dated 15-03-2011 and a copy of the same enclosed hereto).”

6. We have also heard the Ld D.R on this issue, who supported the order passed by Ld CIT(A). The assessee has advanced the loans cited above, apparently on the instructions from the State Government of Kerala. The assessee has provided interest up to the year ending 31.3.2002. Since it did not receive interest so provided and further when it came to its knowledge that these companies have become sick, the directors of the company took a conscious decision not to charge interest, since the recovery of principal itself has become doubtful. The stand taken by the assessee has been strengthened by the subsequent developments, i.e, all the companies have gone into liquidation.

7. An identical issue came to be considered by the Delhi bench of ITAT in the case of Brahamputra Capital & Financial Services Ltd v. ITO [2009] (119 ITD 266). The head notes reported in the CTR Encylopaedia reads as under:-

“Income – Accrual-Interest on sticky loans – Assessee, a non-banking company, even though following mercantile system of accounting, cannot be charged to tax in respect of notional interest on stick loans which was not even accounted for as income by assessee in it books of accounts – Provisions of s. 145(1) are subject to provisions of s. 145(2) and AS-I notified by Central Government under s. 145(2) mandates that notwithstanding method of accounting followed by assessee, financial statement prepared on the basis of method followed must represent a true and fair view of the state of affairs of the business based on the policy of prudence – Provisions of s. 145 cannot override s. 5 and if income has neither actually accrued nor received within the meaning of s. 5, whatever s. 145 may say, such income cannot be charged to tax – Guidance Note on Accrual Basis on Accounting issued by the ICAI lays down that where the ultimate collection with reasonable certainty is lacking, the revenue recognition is to be postponed to the extent of uncertainty involved – Full effect has been given by the as with regard to classification of assets as non-performing assets in terms of the prudential norms of RBI – Assessee was therefore justified in not showing the notional interest income, which did not atually materialize during the year under consideration.”

It is possible to say that the above said decision is rendered in the case of a Non-banking Financial company to which the prudential norms issued by RBI are applicable. However, the Guidance note on Accrual basis of accounting and the Accounting standard on “Revenue recognition” are applicable to all. In the instant case, the assessee did not account the interest income as there was uncertainty about its recovery. The apprehension or the situation foreseen by the assessee has been vindicated by the subsequent developments, which were well highlighted in the written submissions furnished before us. Hence we are of the view that the decision taken by the assessee for not accounting the accrued interest on the reason that there was uncertainty about its recovery cannot be found fault with. It may also be noted that the assessee itself has become defunct.

8. In view of the foregoing discussions, we set aside the orders of Ld CIT(A) and direct the AO to delete the addition made on account of accrued interest income.

9. In the result, both the appeals of the assessee are allowed.