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Income Tax Appellate Tribunal, NAGPUR BENCH, NAGPUR
Before: SHRI P.K. BANSAL & SHRI AMARJIT SINGH
PER AMARJIT SINGH, J.M.
The assessee has filed the present appeal against the order dated
12th December 2014, passed by the learned Commissioner (Appeals)-
I, Nagpur, relevant to the assessment year 2011–12.
Grounds raised by the assessee are reproduced below:–
“1. The learned Assessing Officer erred in law as well as on facts in rejecting the method of accounting followed by the appellant.
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The learned Assessing Officer erred in law as well as on facts in treating a sum of ` 32,12,198 as income accrued to the appellant and thus making an addition of ` 32,12,198.
The addition made by the Assessing Officer amounting to ` 32,12,198 is unjustified, unwarranted and bad–in–law.”
Brief facts of the case are that the assessee filed return of income on 30th September 2011, declaring total income of `
5,94,59,063. The return of income was processed under section
143(1) of the Income Tax Act, 1961 (for short “the Act”). The case
was selected for scrutiny. Notices under section 143(2) and 142(1) of
were issued and served upon the assessee. The assessee firm is
engaged in the activities of hire purchase and lease financing and
providing loans and advances. The gross turnover / receipts are
disclosed at ` 12.77 crore compared to ` 9.55 crore disclosed in the
previous year. The Assessing Officer observed that as per note no.A–7,
of the Schedule–15 of the audited accounts, the assessee adopted
revenue recognition method as under:–
"i. Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Company and the revenue can be reliably measured.
ii. Interest on loans in recognized under the internal rate of return.
iii. Income recognized and remaining unrealization after instalments become overdue for six months or more in case of secured loans are reversed and are accounted as income when these are actually realized.
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iv. Gain or loss arising on securitization of assets is recognized in the year of securitization.
v. Dividend is recognized as income when right to receive payment is established by the balance sheet date.
vi. The Profit/loss on the sale of investments is dealt with at the time of actual sale/ redemption."
The Assessing Officer rejecting the method of accounting
followed by the assessee added a sum of ` 32,12,198 being interest on
such advances reversed by the assessee to the total income.
On appeal, the learned Commissioner (Appeals) confirmed the
order of the Assessing Officer by observing as follows:–
“5.0 I have carefully considered the submissions of the A.R. of the appellant, the order of the AO and the judicial decisions relied upon both sides.
5.1 On careful examination of the facts, it is seen that the A.O. added an amount of ` 32,22,198, being accrued interest, on NPA advances. The appellant is a Non–Banking Finance Company (NBFC), registered with the Reserve Bank of India (RBI). The appellant had advanced certain loans upon which it did not receive interest for more than 6 months. The AR contended that the appellant did not show the interest as its income when the accrued interest has not been paid to it by the debtor continuously for 6 months, treating the said advance as NPA. Thus, as per the RBI directions, the appellant reversed the interest income of Rs. 32,22,198/- being the unrealised NPA interest over due for the period of 6 months and more. The AR of the appellant further contended that the method being followed by the appellant has been accepted by the Department in earlier years. The AR of the appellant has also referred to the relevant RBI directions in this regard in his submissions. The AR further contended that the appellant company follow the accounting standard prescribed u/s 211 (c) of the Companies Act, 1956. The AR stated that the appellant company being in lending business, it is mandatory for it to adopt the AS-9 accounting standard for its revenue recognition. Thus, the AR argued that since there is no
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reasonable certainty about the collectability of interest on advances recognised as NPA, the same has not been recognised by the appellant. The AR further contended that recognising unrealised interest will tantamount to not adhering to the accounting standard prescribed u/s 211 (3C) of Companies Act. Thus, according to the AR, non-compliance to AS-9 goes against the basic intent of sub-section 2 of section 145 of the Income-tax Act, 1961. The AR has relied on the decision of Apex Court int eh case of Shoorji Vallabhdas & Co. 46 ITR 144. The A.R. has also relied on the decision of Hon’ble Madras High Court in the case of Elgi Finance Ltd., 239 ITR 357 (Mad.).
5.2 The decision of the Hon'ble Supreme Court in the case of Southern Technologies Ltd.; 320 ITR 577 (SC) is directly applicable to the issue in hand, wherein the Apex Court has held in favour of the revenue. The relevant extracts of the decision is reproduced below, for better appreciation of facts:
"Non-banking-financial institutions ("NBFCs") face a serious setback after the judgment of the Supreme Court this Monday (11 January 2010) in Southern Technologies Ltd, v. JCIT. This blog has discussed a long-standing controversy in Indian law on the treatment of "sticky" advances. It is useful to briefly recapitulate the contours of this controversy before considering the impact of the Supreme Court's judgment in Southern Technologies. Four circumstances are relevant in this connection - the jurisprudence of the Supreme Court on the "real income theory", a set of circulars issued by the CBDT on the treatment of "sticky" interest, the provisions of the Income Tax Act, 1961, and directions issued by the RBI in 1998 on the treatment of NPAs.
Of the entire sum of money that is lent to various borrowers by banks and NBFCs, a significant part of the interest payable is considered "sticky", for it represents interest on principal that is unlikely to be recovered, and which the borrower has not serviced for some length of time. Under certain circumstances, these sticky advances are considered "Non-Performing Assets" (NPA) and in other cases, are written off entirely as bad debts. The latter case presents no difficulty, since a bad debt is a deductible business expenditure, provided it is written off bona fide. However, assessees argued that sticky loans do not constitute "income" in the first place, and relied for this purpose on the "real income theory", which posits that the classification of a receipt as an income must bear some relationship to commercial reality. In 1952, the CBDT issued a circular clarifying that interest entered in the suspense account by an assessee is not part of total income, because of the "extreme unlikelihood" in recovering the principal. This circular was withdrawn in 1978. In 1986, the Supreme Court, in State Bank of Travancore v. CIT, partly relied on this withdrawal
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to hold that the real income theory does not support the proposition that sticky interest is non-taxable. However, the CBDT, in 1984, had issued another circular clarifying that interest on loans that have not been repaid for three successive years is not taxable. As the Court in SBT had not noticed this circular, the case was overruled in 1999 and again in 2006. However, what is significant is that this was not an unqualified approval of the real income theory, but rather a decision that the particular circulars applied to banks to the extent specified in those circulars.
A series of retrospective amendments to the Income Tax Act added to the lack of clarity in this area. S. 36(l)(vii) of the Act originally provided that the amount of any bad debt written off in the accounts of the assessee as irrecoverable is a deductible expense. However, an Explanation was added to this provision in 2001 with retrospective effect, providing that this does not include a "provision" for bad debts. In 1997, an amendment with retrospective effect from 1989 added clause vii(a), which provided that a scheduled bank could deduct provisions for bad and doubtful debts upto a specified percentage. S. 43D was also amended in 1999 to provide that income in relation to categories of bad and doubtful debts prescribed by the Reserve Bank of India are chargeable to tax only when the income is actually received by the scheduled bank or credited to the Profit & Loss account in its books. Notably, neither s. 36(l)(viia) nor s. 43D applies to NBFCs. To complete the account of the circumstances that led to Southern Technologies, it is relevant to refer to what turned out to be the crux of the controversy - the effect of the 1998 directions of the RBL In these Directions, the RBI defined an NPA as "any asset in respect of which interest has remained due for more than six months", and directed NBFCs to recognise these assets as income only when income is actually received. By virtue of s. 45Q of the RBI Act, these Directions override all laws to the contrary.
In Southern Technologies, NBFCs relied on all these circumstances to challenge the taxability of NPAs and other sticky assets. In particular, assessees argued that the beneficial provisions of s. 36(l)(viia) and s. 43D must be construed to be applicable to NBFCs as well, and that confining their application to banks violates Art. 14 of the Constitution. In short, NBFCs contended that they were on exactly the same footing as banks for the purposes of the treatment of NPAs, and that the differentia between banks and NBFCs in this provision lacks any rational nexus. The assessees also relied on the real income theory to suggest that sticky interest is non-taxable. The Supreme Court rejected all these contentions and held that such income is taxable.
The following is a summary of the decision of the Court:
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a) The RBI Directions do not have any relevance to the treatment of taxable income, for the RBI Act and the IT Act operate in different fields. The RBI Act overrides the Companies Act, 1956, to the extent of presentation of accounts, but does not override the Income Tax Act.
(b) The distinction between banks and XBFCs in ss. 36(lXviia) and 43D is not violative of Art. 14 of the Constitution.
(c) The "real income" theory requires courts to recognise that a mere provision for bad and doubtful doubts is not a "real" expense that may be deducted.
(d) Section 37 does not apply to cases that fall within s. 36 but are specifically excluded by an Explanation.
This decision appears to have settled the latest chapter in a long- standing and complex controversy on the treatment of sticky interest."
5.3 Thus, having considered the ratio laid down by the Apex Court on the issue and the other judicial decisions relied upon by the AO and the Circular of the CBDT, I decline to interfere with the order of the AO. I, therefore, uphold the action of the AO to tax the NPA interest accrued to the appellant company.”
The assessee being aggrieved by the aforesaid order of the
learned Commissioner (Appeals), filed appeal before the Tribunal.
Before us, the learned Counsel for assessee submitted that the
assessee company for the assessment year under consideration filed
its return declaring income at ` 5,94,93,063, which has been assessed
on a total income of ` 6,26,81,260 under section 143(3) of the Act on
24th October 2013. He submitted that the assessee company
recognises the revenue after reversing the interest on the installments
become over due for six months and more and such interest is
accounted for as income as and when they are actually realised. The
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learned Counsel for assessee further submitted that the assessee
company is following the same method of accounting year–after–year
and the same is accepted by the Department in earlier years. He
submitted that the Assessing Officer rejecting the method of
accounting added a sum of ` 32,12,198, being interest on such
advances reversed by the assessee to the income of the assessee
company. The learned Counsel, however, submitted that the issue is
covered by the decision of the Hon’ble Jurisdictional High Court in CIT
v/s KEC Holdings Ltd., 330 ITR 440 (Bom.).
The learned Departmental Representative relied upon the
observations of the authorities below.
Having heard the rival contentions and on a perusal of the orders
of the authorities below and the case law relied upon by the learned
Counsel for assessee, we find that the issue for our adjudication is
covered by the decision of the Hon’ble Jurisdictional High Court in KEC
Holdings Ltd. (supra), wherein the Hon’ble Bombay High Court
observed as follows:–
“9] We do not find that the Tribunal has either misdirected itself in law or its order can be termed as perverse warranting interference in our appellate jurisdiction. We find that the view taken by the Tribunal accords with the Reserve Bank of India guidelines and which are not in any way in conflict with the Income Tax Act, 1961, the Hon'ble Supreme Court has held in the case of UCO Bank that the interest income would have been brought to the Profit and Loss Account provided it was actually
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realized, that in case of Nationalized Bank it treated something which is doubtful, and therefore, kept it in a suspense account, was held to be a permissible exercise. In respect of the loans which are advanced, recovery of some of them if considered doubtful, then, even the interest on the loans advanced may not be realized. That is how the amount is not brought to the profit and loss account because they are not likely to be realized by the bank or a NBFC as well. It is permissible therefore to disclose or to show them as income in assessment year in which either the interest amount or part of it is recovered. The Tribunal in this case, namely, of the assessee before us, has precisely followed this course. We do not find that the course permitted and upheld by the Tribunal is in any way in conflict with any legal provisions or the settled principles. Rather as held by us, it is in accordance with the same. Once the view taken by the Tribunal was possible and in the given facts and circumstances the income has not been realized by the assessee, the addition was rightly deleted. We, therefore, do not find that the appeal raises any substantial question of law. It is accordingly dismissed. No costs.”
Respectfully following the aforesaid observation of the Hon’ble
Jurisdictional High Court, we set aside the impugned order passed by
the learned Commissioner (Appeals) and allow the ground raised by
the assessee.
In the result, assessee’s appeal stands allowed.
Order pronounced in the open Court on 30.06.2017
Sd/- Sd/- P.K. BANSAL AMARJIT SINGH VICE PRESIDENT JUDICIAL MEMBER
NAGPUR, DATED: 30.06.2017
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Copy of the order forwarded to:
(1) The Assessee; (2) The Revenue; (3) The CIT(A); (4) The CIT, Nagpur City concerned; (5) The DR, ITAT, Nagpur; (6) Guard file. True Copy By Order Pradeep J. Chowdhury Sr. Private Secretary
(Dy./Asstt.Registrar) ITAT, Nagpur