THE DY. COMMISSIONER OF INCOME TAX, JALANDHAR vs. THE NAWANSHAHR CENTRAL CO-OP BANK LTD, NAWANSHAHR

IN THE INCOME TAX APPELLATE TRIBUNAL AMRITSAR BENCH; AMRITSAR. BEFORE SH. T. S. KAPOOR, ACCOUNTANT MEMBER AND SH. N. K. CHOUDHRY, JUDICIAL MEMBER I.T.A. No. 61/(Asr)/2017 Assessment Year: 2013-14 PAN: AAAAT4125G The Dy. C. I. T. Vs. The Nawanshahr Central Co-op. Circle-II, Jalandhar. Bank Ltd. Nawanshahr, Distt. Doaba. (Appellant) (Respondent)

Appellant by : Sh. S. S. Kanwal (D. R.) Respondent by: Sh. Rakesh Joshi (Adv.) Date of Hearing: 24.10.2017 Date of Pronouncement: 03.01.2018

ORDER PER T. S. KAPOOR (AM): This is an appeal filed by revenue against the order of Ld. CIT(A),

Jalandhar, dated 16.12.2016 for Asst. Year: 2013-14.

“1. That on the facts and in the circumstances of the case the Ld. CIT(A) has erred in law as well as on facts in deleting the addition of Rs. 1,13,35,169/- made by the A.O. on account of disallowance of interest on Non Performing Assets." 1(a). That while deleting ^he above addition of Rs. 1,13,35,169/-Ld. CIT(A) has erred on facts as well as in law by ignoring the fact that the assessee is neither following Mercantile* System of Accounting nor Cash System of Accounting and is in fact following a mixed/hybrid system of accounting, which is not a recognized system of accounting. 2. That on the facts and in the circumstances of the case the Ld. CIT(A) has erred in law as well as on facts in deleting the addition of Rs. 34,00,000/- made by the A.O. on account of disallowance of Provision against Standard Assets.

2 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 1(a). That while deleting the above addition of Rs. 34,00,000/-Ld. CIT(A) has erred on facts as well as in law by ignoring the fact that this disallowance was made by the A.O. in the light of provisions of section 36(l)(viia) of the Income Tax Act, 1961 wherein only provisions in case of “bad and doubtful debts” has been mentioned as allowable whereas in assessee’s case the provision pertains to “Standard Assets” 3. It is prayed that the order of the Ld.CIT(A) be set-aside and that of the Assessing Officer restored. 4. That the appellant requests for leave to add or amend or alter the grounds of appeal before the appeal is heard and disposed off.

case are squarely covered in favour of the assessee by the order of the

Hon'ble Tribunal in ITA No. 652/Asr/2015, 604&605/Asr/2016 in the

case of M/s Jalandhar Central Cooperative Bank Ltd. and also covered

by the order of the Tribunal in the case of M/s Punjab Gramin Bank and

Moga Central Cooperative Bank Ltd. vide order dated 04.10.2017 and

15.03.2017 respectively.

account of provision of interest on Non Performing Assets and

disallowance of provisions against standard assets.

the assessee.

placed on record. We find that the Assessing Officer has disallowed the

provisions which the assessee has made on standard assets and has also

made addition on account of interest on Non Performing Assets which

the assessee had not taken into account. We find that these issues are

3 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 squarely covered in favour of the assessee by the orders of the Tribunal

in the case of M/s Punjab Gramin Bank and also in the case of Moga

Central Cooperative Bank. The findings of the Hon'ble Tribunal in the

case of Moga Central Cooperative Bank are reproduced below:

“6. We have heard the rival parties and have gone though the material placed on record. We find that the issue involved in these appeals, is regarding non declaration of interest income on non performing assets by the assessee. The Hon'ble Amritsar Bench in the case of Jalandhar Central Co-operative Bank Ltd. vide its order dated 20.01.2017 has dismissed the appeals filed by revenue and similarly in the case of Kapurthala Central Co-operative Bank Ltd., the Amritsar Bench has again dismissed the appeals filed by revenue on similar issue. The Hon'ble Chandigarh Bench vide its order dated 03.01.2017 in ITA No. 526/Chd/2013 has also dismissed the appeal filed by revenue under same facts and circumstances. While dismissing the appeal, the Hon'ble Tribunal has discussed the case law of Hon'ble Supreme Court in the case of State Bank of Travancore and has held that it has been overruled by the Apex Court itself in the case of UCO Bank Ltd. (supra) and therefore the grievance of the revenue is not justified. For the sake of completeness the decision of the Hon'ble Chandigarh Bench of Tribunal in the case of Ludhiana Central Co-operative Bank Ltd. The findings of Hon'ble Tribunal as contained from para 13 are reproduced below:

“13. We find that the issue of accounting for interest on sticky loans/NPA’s, has been dealt with in a number of decisions both by the Apex Court and various High Courts and Tribunals also, wherein after applying the “Real Income Theory”, the prescribed Accounting Standard issued by ICAI on Revenue Recognition, AS-9, the accounting practice of the assessee relating to interest on sticky loans and the RBI guidelines relating to accounting for interest on NPA’s, it was held that such income was taxable in the year of receipt only, when its realization becomes reasonably certain.

“We have to consider whether interest on a loan whose recovery is doubtful and which has not been recovered by the assessee-bank for the last three years but has been kept in a suspense account and has not been brought to the profit and loss account of the assessee, can be included in the

4 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 income of the assessee for the assessment year 1981-82. It is the case of the assessee that in respect of loans which are advanced by it to various customers, recovery of some loans is very doubtful. It is doubtful whether even the interest on the loans advanced will be recovered from the customer. In such cases, the interest calculated on the loan amount is credited in a suspense account. This amount is not brought to the profit and loss account of the assessee-bank because these are amounts which are not likely to be realized by the bank. Hence they do not form a part of the real income of the bank. If and when any such amount or a part of it is recovered, it is included in that assessment year in the total income of the assessee for the purpose of payment of income- tax. The method of accounting which is followed by the assessee-bank is mercantile system of accounting. However, the assessee considers income by way of interest pertaining to doubtful loans as not real income in the year in which it accrues, but only when it is realized. A mixed method of accounting is thus followed by the assessee-bank. This method of accounting adopted by the assessee is in accordance with accounting practice. In Spicer and Pegler's Practical Auditing the relevant passage occurring at page 186-187 has been reproduced in the minority judgment of this Court in State Bank of Travancore v. Commissioner of Income-tax, Kerala [(1986) 158 ITR 102 at p.i2o]. It is as follows: "Where interest has not been paid, it is sometimes left out of account altogether. This prevents the possibility of irrecoverable interest being credited to revenue, and distributed as profit. On the other hand, this treatment does not record the actual state of the loan account, and in the case of banks and other concerns whose business it is to advance money, it is usual to find the interest is regularly charged up, but when its recovery is doubtful, the amount thereof is either fully provided against or taken to the credit of an Interest Suspense Account and carried forward and not treated as profit until actually received." Similarly, referring to interest on doubtful debts, Shukla and Grewal on Advanced Accounts, Ninth Edition at page 1089 state as follows: "Interest on doubtful debts should be debited to the loan account concerned but should not be credited to interest account. Instead, it should be credited to Interest Suspense Account. To the extent the interest is received in cash, the Interest Suspense Account should be transferred to Interest account; the remaining amount should be closed by transfer to the Loan account. This treatment accords with the 11 principle that no item should be treated as income unless it has been received or there is a reasonable certainty that it will be realized.

(Vide State Bank of Tranvacore v. CIT [supra]) The assessee's method of accounting, therefore, transferring the doubtful debt to an interest suspense account and not treating it as

5 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 profit until actually received, is in accordance with accounting practice.

Under Section 145 of the Income-tax Act, 1961, income chargeable under the head "profits and gains of business or profession or income from other sources" shall be computed in accordance with the method of accounting regularly employed by the assessee; provided that in a case where the accounts are correct and complete but the method employed is such that in the opinion of the Income- tax Officer, the income cannot properly be deduced therefrom, the computation shall be made in such manner and on such basis as the Income-tax Officer may determine. In the present case the method employed is entirely for a proper determination of income.” (emphasis supplied by us)

“The question whether interest earned, on what have come to be known as "sticky" loans, can be considered as income or not until actual realization, is a question which may arise before several income tax officers exercising jurisdiction in different parts of the country. Under the accounting practice, interest which is transferred to the suspense account and not brought to the profit and loss account of the company is not treated as income. The question whether in a given case such "accrual" of interest is doubtful or not, may also be problematic. If, therefore, the Board has considered it necessary to lay down a general test for deciding what is a doubtful debt, and directed that all income tax officers should treat such amounts as not forming part of the income of the assessee until realized, this direction by way of a circular cannot be considered as travelling beyond the powers of the Board under Section 119 of the Income Tax Act. Such a circular is binding under Section 119. The circular of 9th of October, 1984, therefore, provides a test for recognizing whether a claim for interest can be treated as a doubtful claim unlikely to be recovered or not. The test provided by the said circular is to see whether, at the end of three years, the amount of interest has, in fact, been recovered by the bank or not. If it is not recovered for a period of three years, then in the fourth year and onwards the claim for interest has to be treated as a doubtful claim which need not be included in the income of the assessee until it is actually recovered.”

6 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 17. Further the issue of taxability of interest on NPA accounts on receipt basis by Cooperative Banks has been dealt with by various High Courts, wherein it was held that the assessee was bound by RBI guidelines to account for such interest on receipt basis and by virtue of the provisions of section 45Q of the RBI Act, the RBI guidelines had an overriding effect over other Acts including the Income Tax Act, 1961.

“20. Section 45Q finds place in Chapter IIIB of the RBI Act. Thus, the provisions of Chapter IIIB of the RBI Act have an overriding effect qua other enactments to the extent the same are inconsistent with the provisions contained therein. In order to reflect a bank's actual financial health in its balance sheet, the Reserve Bank has introduced prudential 13 norms for income recognition, asset classification and provisioning for advances portfolio of the co-operative banks. The guidelines provided thereunder are mandatory and it is incumbent upon all co-operative banks to follow the same. Insofar as income recognition is concerned, clause 4.1.1 of the circular provides that 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. Thus, in view of the mandate of the RBI Guidelines the assessee cannot recognise income from non-performing assets on accrual basis but can book such income only when it is actually received. Thus, this is a case where at the threshold, the assessee, in view of the RBI Guidelines, cannot recognize income from NPA on accrual basis. This is, therefore, a case pertaining to recognition of income and not computation of the income of the assessee.

7 ITA No. 61(Asr)/2017 Assessment Year: 2013-14

"42. Broadly, there are three deviations: (i) in the matter o f presentation o f financial statements under Schedule VI to the Companies Act; (ii) in not recognizing the "income" under the mercantile system o f accounting and its insistence to follow cash system with respect to assets classified as 14 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 o f recovery under the norms of the accounting standards issued by the Institute o f Chartered Accountants of India.

These deviations prevail over certain provisions of the Companies Act, 1956 to protect the depositors in the context o f income recognition and presentation o f the assets and provisions created against them. Thus, the P&L account prepared by NBFC in terms o f the RBI Directions, 1998 does not recognize "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 o f provisions. [Emphasis supplied]"

"Applicability of Section 145

8 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 nothing to do with computation o f taxable income. These Directions cannot overrule the "permissible deductions" or "their exclusion" under the IT Act. The inconsistency between these Directions and the Companies Act is only in the matter of income recognition and presentation o f 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 AO comes to the conclusion that such change would result in understatement of profits. However, here is the case where the AO has to follow the RBI Directions, 1998 in view o f Section 45-Q o f the RBI Act. Hence, as far as income recognition is concerned, Section 145 of the IT Act has no role to play in the present dispute."

Thus, insofar as income recognition is concerned, the court has held that even the Assessing Officer has to follow the RBI Directions, 1998 in view of section 45Q of the RBI Act and that as far as income recognition is concerned, section 145 of the Income Tax Act, has not role to play.

Hence, the Assessing Officer has to follow the RBI Directions.

“25. The distinction drawn by the Delhi High Court is that while the accounting policies of adopted by the NBFC cannot determine the taxable income. However, insofar as income recognition is concerned, the

9 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 Assessing Officer has to follow the RBI Directions, 1998 in view of section 45Q of the RBI Act. That insofar as income recognition is concerned, section 145 of the Income Tax Act, 1961 has no role to play.”

“9. The Income Tax Appellate Tribunal has referred the case of M/s. Vasisth Chay Vyapar Limited 330 ITR 440 (Delhi). In this case, the revenue relied upon the decision of the Hon'ble Supreme in the case of Southern Technologies Ltd. supra. The learned Income Tax Appellate Tribunal has reproduced the observations made by the Delhi High Court while referring the said case of M/s Southern Technologies Limited supra. The assessee herein being a Cooperative Bank also governed by the Reserve Bank of India and thus the directions with regard to the prudential norms issued by the Reserve Bank of India are equally applicable to the Co-operative banks. The Hon'ble Supreme Court in the case of Southern Technologies Limited supra held that, provisions of Section 45Q of Reserve Bank of 17 India Act has an overriding effect vis-a-vis income recognition principle under the Companies Act. Hence, Section 45Q of the RBI Act shall have overriding effect over the income recognition principle followed by cooperative banks. Hence, the Assessing Officer has to follow the Reserve Bank of India directions 1998, as held by the Hon'ble Supreme Court.”

10 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 case of K.P.Varghese Vs. ITO (1981) 131 ITR 597 (SC). The relevant extracts of the decision in UCO Bank Limited are reproduced hereunder:

"There are, however, two decisions of this Court which have been strongly relied upon by the respondents in the present case. The first decision is the majority judgment in The State Bank of Travancore v. Commissioner of Income- Tax, Kerala (1986 (158) ITR 102) decided by a Bench of three Judges of this court by a majority of two to one. This judgment directly deals with interest on "sticky advances" which have been debited to the customer but taken to the interest suspense account by a banking company. The majority judgment has referred to the circular of 6th of October, 1952 and its withdrawal by the second circular of 20th of June, 1978. The majority appears to have proceeded on the basis that by the second circular of 20th of June, 1978 the Central Board had directed that interest in the suspense account on "sticky" advances should be includible in the taxable income of the assessee and all pending cases should be disposed of keeping these instructions in view. The subsequent circular of 9th of October, 1984 by which, from the assessment year 1979-80 the banking companies were given the benefit of the circular of 9th of October, 1984, does not appear to have been pointed out to the Court. What was submitted before the Court was, that since such interest had been allowed to be exempted for more than half a century, the practice had transformed itself into law and this position should not have been deviated from. Negativing this contention, the Court said that the question of how far the concept of real income enters into the question of taxability in the facts and circumstances of the case, and how far and to what extent the concept of real income should intermingle with the accrual of income, will have to be judged "in the light of the provisions of the Act, the principles of accountancy recognised and followed, and feasibility". The Court said that the earlier circulars being executive in character cannot alter the provisions of the Act. These were in the nature of concessions which could always be prospectively withdrawn. The Court also observed that the circulars cannot detract from the Act. The decision of the Constitution Bench of this Court in Navnitlal C. Javeri v. K.K. Sen (Supra), or the subsequent decision in K.P. Varghese v. 19 Income Tax Officer (supra) also do not appear to have been pointed out to the Court. Since the later circular of 9.10.1984 was not pointed out to the Court, the Court naturally proceeded on the

11 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 assumption that the benefit granted under the earlier circular was no longer available to the assessee and those circulars could not be resorted to for the purpose of overcoming the provisions of the Act. Interestingly, the concurring judgment of the second judge has not dealt with this question at all but has decided the matter on the basis of other provisions of law. "

In view of the above judicial precedents, ground no. 1 of revenue’s

appeal is dismissed.

12 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 Now coming to ground no. 2 regarding provisions against the

standard assets, we find that the same is also covered in favour of

assessee by the order of the Hon'ble Tribunal in the case of Punjab

Gramin Cooperative Bank. For the sake of completeness, the findings of

the Hon'ble Tribunal are reproduced below:

“12. We have heard the rival parties and have gone through the material placed on record. We find that the issue of provision for doubtful debts on standard assets is covered in favour of assessee by the order of the Tribunal dated 22.06.2016 for Assessment Year: 2008-09, wherein the appeal of the revenue was dismissed which was filed by Revenue on similar grounds. The relevant findings of the Tribunal as contained in para 8 onwards are reproduced below. 8. “We have heard the rival parties and have gone through the material on record. We find that the assessee had created a provision of Rs. 50,00,000/- which included a sum of Rs. 13,25,000/- as provisions for bad and doubtful debts and the balance amount of Rs. 36,75,000/- was provision against standard assets and the entire amount was claimed as deduction under section 36(1)(viia) of the Act. The Assessing Officer was of the opinion that the provisions made by the assessee against standard assets was a contingent liability and which was not allowable as business expenditure. The Ld. CIT(A), however, allowed relief to the assessee by holding that the claim of the assessee fall into the main provisions of section 36(1)(viia). To resolve the dispute it is important to visit the provisions of section 36(1)(viia) of the Act and which for the sake of convenience are reproduced below. “36(1)(viia) In respect of any provision for bad and doubtful debts made by (a) a scheduled bank [not being a bank incorporated by or under the laws of a country outside India] or a non-scheduled bank or a co-operative bank outside India] or a primary co-operative agricultural and rural development bank, an amount not exceeding seven and one- half percent of the total income (computed before making any deduction under this clause and Chapter VI-A) and an amount not exceeding ten percent of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner. Provided that a schedule bank or a non-scheduled bank referred to in this sub-clause shall, at its option, be allowed in any of the relevant assessment years deduction in respect of any provision made by it for any assets classified by the

13 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, for an amount not exceeding five percent of the amount of such assets shown in the books of account of the bank on the last day of the previous year. Provided further that for the relevant assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, the provisions of the first proviso shall have effect as if for the words “five percent”, the words “ten percent” had been substituted. Provided also that a scheduled bank or a non-scheduled bank referred to in this sub-clause shall, at its option, be allowed a further deduction in excess of the limits specified in the foregoing provisions, for an amount not exceeding the income derived from redemption of securities in accordance with a scheme framed by the Central Government. Provided also that no deduction shall be allowed under the third proviso unless such income has been disclosed in the return of income under the head “Profits and gains business or profession.” From the above provisions it can be seen that deduction u/s 36(1) (viia) of the Act is allowed in respect of provisions for bad and doubtful debts. This section does not differentiate between provision on bad assets and provision on standard assets. This deduction exclusively allows deduction in respect of provision for bad and doubtful debts to the extent mentioned in the various clauses of sub-section (1) of section 36 of the Act. The deduction under section 36(1)(viia) of the Act is allowed only in respect of certain specific categories of assessee mentioned in the clause like banks, financial institutions, etc. who are in business of lending money. It is not allowed even to non-banking financial institutions since they are not included in this clause. It is seen that though section 36(1) (vii) states that deduction for provision is allowable in respect of provision for bad and doubtful debts, the computation of such deduction is made with reference to total income of the specified Banks based upon quantum of average advances. The deduction of the provisions is neither limited to the quantum of bad debts in the books nor is computed with reference to the quantum of standard assets. The deduction in this clause refers to allowable provisions of anticipated default on the loans and advances made in respect of total assets including standard assets and the claim of the assessee does not fall into the proviso to section 36(1) (viia) as the proviso deals with further deduction for provisions on bad and doubtful debts. The claim of the assessee is covered in the main provisions of section 36(1)(viia) of the Act. The Ld. CIT(A) has passed a

14 ITA No. 61(Asr)/2017 Assessment Year: 2013-14 very exhaustive and speaking order and we do not find any infirmity in the same. Therefore following the above Tribunal order, we do not see any infirmity in the order of Ld. CIT(A). 13. In view of the above fact and circumstances the grounds of appeal raised by Revenue in ITA No. 580 & 569 are dismissed.

In view of the above precedents the ground no. 2 is also dismissed.

Order pronounced in the open court on 03.01.2018

Sd/- Sd/- (N. K. CHOUDHRY) (T. S. KAPOOR) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 03.01.2018. /GP/Sr. Ps. Copy of the order forwarded to: (1) The Assessee: (2) The (3) The CIT(A), (4) The CIT, (5) The SR DR, I.T.A.T., True copy

By Order