D.C.I.T CIR - 8,KOLKATA., KOLKATA vs. M/S MEDPAT FINANCE LIMITED, KOLKATA

ORDER SHRI M.BALAGANESH, AM :

This appeal of the revenue arises out of the order passed by the Learned CIT(A), VIII, Kolkata in Appeal No. 277/CIT(A)-VIII/Kol/11-12 for the Asst Year 2009-10 dated 17-12-2012 against the order of assessment passed by the Learned AO u/s. 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the ‘Act’).

2.1. The brief facts of this issue is that the assessee is a non-banking finance company and is holding certificate of registration from Reserve Bank of India to carry on the business of non banking finance company with effect from 27.2.1998. During the course of assessment proceedings, the Learned AO noticed that the assessee had derived

M/s. Medpat Finance Limited 1 dividend income which is exempt to the tune of Rs. 180/- and assessee was requested to show cause as to why the proportionate expenses deemed to have been incurred in relation to the dividend income should not be disallowed u/s 14A of the Act read with Rule 8D of the Rules. In response to the said show cause notice, the assessee replied that the investment of Rs. 2,21,18,521/- was made by the assessee out of share capital and out of taxed accumulated profits over the years and no expenditure has been incurred on the investment which has been charged to profits of the assessee company as per profit and loss account. The Learned AO ignoring the submissions of the assessee directly adopted Rule 8D of the Rules and made disallowance u/s 14A of the Act to the tune of Rs. 10,21,245/-. On first appeal, the Learned CITA held that the assessee’s net owned funds as on 31.3.2009 were Rs. 11.29 crores and as on 31.3.2008 was Rs. 7.02 crores. The assessee’s investment in shares during the year went up only by Rs 1.5 lacs. These facts therefore supports the assessee’s case that more than 99% of investment was brought forward from earlier years. He also found that no disallowance u/s 14A of the Act was made for earlier assessment years. He found that the Learned AO had directly embarked on applying Rule 8D(2) of the Rules without recording any satisfaction with cogent reasons in terms of Rule 8D(1) of the Rules as to why the submission of the assessee that no expenditure was incurred for earning dividend income is incorrect. He further held that the Learned AO had not brought any nexus between use of borrowed funds with acquisition of investments. Accordingly, he held that no disallowance need to be made in terms of Rule 8D(2)(ii) of the Rules. However, in respect of disallowance contemplated under Rule 8D(2)(iii) for management expenses, he directed the Learned AO to disallow a sum of Rs. 25,000/- to meet the ends of justice. The assessee had not preferred further appeal before us against this order. The revenue is in appeal before us on the following ground:- “1. That on the facts and circumstances of the case and in law, the ld.CIT(A) erred in deleting the action of AO in disallowing a sum of Rs.10,21,245/- invoking the provisions of section 14A r.w.r 8D.”

M/s. Medpat Finance Limited 2 2.2. The Learned DR argued that disallowance u/s 14A of the Act is mandatorily to be made and hence pleaded for restoration of order of the Learned AO. In response to this, the Learned AR vehemently supported the order of the Learned CIT(A).

2.3. We have heard the rival submissions. We hold that the Learned CIT(A) had given cogent reasons in his appellate order to disallow a sum of Rs. 25,000/- towards proportionate management expenses in terms of Rule 8D(2)(iii) of the IT Rules as the expenditure deemed to have incurred by the assessee for the purpose of earning dividend income of Rs. 180/-. The factual findings given by the Learned CIT(A) with regard to the availability of own funds with the assessee for the purpose of making the investments have not been controverted by the Learned DR before us. Hence no disallowance is warranted in terms of Rule 8D(2)(ii) of the Rules.

In view of the aforesaid facts and circumstances , we do not find any infirmity in the order of the Learned CIT(A) and accordingly, the ground no.1 raised by the revenue is dismissed.

3.1. The brief facts of this issue is that assessee being a non banking finance company advanced monies under hire purchase scheme to M/s Guru Mehar Construction during the financial year 2003-04 relevant to Asst Year 2004-05 for acquiring vehicles. The hire purchase finance charges was recognized as income on mercantile basis by the assessee from the inception of the contract in respect of this party M/s Guru Mehar Construction till Asst Year 2007-08. During Asst Year 2008-09, the said hire purchase account became non-performing asset (NPA) due to default in payment of installments. The assessee being a non- banking finance company is bound to comply with the M/s. Medpat Finance Limited 3 prudential norms prescribed by the Reserve Bank of India in respect of income recognition , classification of assets and provision for NPA requirements in accordance with section 45IA and 45Q of Reserve Bank of India Act. The said prudential norms of RBI mandate the assessee to recognize interest income on NPA accounts only on receipt basis irrespective of the method of accounting employed by the assessee. Since the assessee could not realize the interest from the said party i.e Guru Mehar Construction, it chose not to recognize interest income on accrual basis in consonance with prudential norms prescribed by RBI for the Asst Years 2008-09 and 2009-10. The Learned AO obtained information from M/s Guru Mehar Construction u/s 133(6) of the Act who had provided for interest payable to assessee to the extent of Rs. 1,23,56,247/- and based on this data, the Learned AO proceeded to make an addition for the same amount in the hands of the assessee as interest income from Guru Mehar Construction ignoring completely the submissions of the assessee as stated supra. On first appeal, the Learned CITA by relying on the decision of the Hon’ble Delhi High Court in the case of CIT vs Vasisth Chay Vyapar Ltd reported in 330 ITR 440 (Delhi) held that the prudential norms prescribed by RBI with regard to income recognition are to be mandatorily followed by the assessee being a NBFC and further going by the concept of ‘real income’ theory where in the instant case, even the receipt of principal is doubtful of recovery, the question of recovery of interest does not arise and accordingly deleted the addition made by the Learned AO. Aggrieved, the revenue is in appeal before us on the following ground:- “2. That on the facts and circumstances of the case and in law, the ld.CIT(A) erred in deleting the addition made by AO of Rs.1,23,56,247/- as interest income in the hands of the assessee for year under consideration. “ 3.2. The Learned DR vehemently supported the order of the Learned AO and in response to this the Learned AR vehemently supported the order of the Learned CIT(A).

M/s. Medpat Finance Limited 4 3.3. We have heard the rival submissions and perused the materials available on record. The facts stated hereinabove remain undisputed by both the parties and hence are not reiterated herein for the sake of brevity. We find that having regard to the provisions of RBI Act 1934 and directions made thereunder with regard to income recognition , it is apparent that the account of M/s Guru Mehar Construction constituted Non-Performing Asset (NPA) and therefore income thereon could be booked only on receipt basis by the assessee irrespective of the method of accounting employed by the assessee. We find that this issue has been elaborately and judicially adjudicated by the Hon’ble Delhi High Court in the case of CIT vs Vasisth Chay Vyapar Ltd reported in 330 ITR 440 (Delhi) wherein the relevant provisions of the IT Act, RBI Act, Accounting guidelines issued by RBI and ICAI Accounting Standards on Revenue Recognitioin have been duly considered and held that in case of NBFCs, the income recognition can only be done in conformity with revenue recognition norms laid down by RBI. The relevant operative portion of the Delhi High Court judgement is reproduced herein below:- “It was not in dispute that on the application of the provisions of the RBI Act and the 1998 Directions, the ICDs advanced to ‘S’ by the assessee had become NPA. It was also not in dispute that the assessee-company being NBFC was bound by the aforesaid provisions. Therefore, under the aforesaid provisions, it was mandatory on the part of the assessee not to recognize the interest on the ICDs as income having regard to the recognized accounting principles. The accounting principles, which the assessee was indubitably bound to follow, were AS-9. [Para 16] Therefore, it could not be said that income in the form of interest, though not received, had still accrued to the assessee under the provisions of the Income-tax Act and was, therefore, exigible to tax. It was so for the reasons: (1)The assessee had not received any interest on the said ICDs placed with ‘S’ since the assessment year 1996-97 as it had become NPA in accordance with the Prudential Norms, which was entered in the books of account as well. The assessee had further successfully demonstrated that even in the succeeding assessment years, no interest was received and the position remained the same until the assessment year 2006-07. Reason was adverse financial circumstances and the financial crunch faced by ‘S’. So much so, it was facing winding up petitions which were filed by many

M/s. Medpat Finance Limited 5 creditors. Those circumstances led to an uncertainty insofar as, recovery of interest was concerned, as a result of the aforesaid precarious financial position of ‘S’. What to talk of interest, even the principal amount itself had become doubtful to recover. In that scenario, it was legitimate move to infer that interest income thereupon had not ‘accrued’.

3.3.1. We also find that the Hon’ble Supreme Court in the case of Southern Technologies Ltd reported in 320 ITR 577 (SC) had held as follows:-

“It is well settled that accounting policy followed by a company can be changed unless the AO comes to the conclusion that change would result in under statement of profit. However here is a case where the AO has to follow the RBI directions 1998 in view of section 45Q of 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.”

3.3.2. We also find that the Learned CIT(A) had made the following observations :- “5.2.6 I, therefore, find that in the matter of revenue recognition the Supreme Court in principle accepted the legal proposition that in view of Sec 45Q of the RBI Act, the income recognition principles prescribed by the RBI act and directions there-under were having over riding effect in the assessments of the NBFCs and therefore no income in relation to loan assets qualified as NPA can be assets till its realization even though u/s. 145 of the I T Act such NBFC assesses followed mercantile system of accounting. In fact I note that no contrary provision exists contained in the I.T Act which is contrary to RBI’s prudential revenue recognition norms. In this factual background and in view of the over riding provisions of Sec 45Q of the RBI Act 1934, the AO was bound to follow the revenue recognition principles engrained in the RBI’s Prudential Norms in assessing total income of the appellant. This proposition is also accepted by the Jurisdictional Calcutta High Court in the case of CIT Vs. KICM Investments Ltd and SLP against that decision was dismissed by the Supreme Court. In the light of these judicial decisions I have no hesitation in holding that the appellant which was an NBFC was liable to follow Prudential Accounting Norms. In terms of the said RBI directions the appellant could not have recognized revenue in respect of the loans granted to Guru Mehar Construction since it had continuously defaulted on payment of interest for more than 6 months period and thereby classified as NPA. In the circumstances merely because the appellant followed the mercantile system of accounting, the AO could not assess the M/s. Medpat Finance Limited 6 alleged accrued interest of Rs.1,23,56,247/- as income of the appellant chargeable in AY 2009-10.

5.2.7 The AO also justified the addition of the alleged interest on the ground that in its confirmation, Guru Mehar Construction had admitted that the appellant’s accounts in its books for FY 2008-09 was credited by the sum of Rs.1,2356,247/- in respect of accrued interest and over due interest. In AO’s opinion the appellant was liable to be assessed on such interest because in the books of the borrower it had accounted the interest expenditure and therefore the appellant could not escape the liability to pay tax on accrued interest by taking shelter of the theory of real income. In my considered opinion however merely on the basis of entries passed in the books of the borrower, tax liability of the lender could not be artificially determined. The confirmation issued by the borrower proved that except crediting interest to the appellant’s account, it did not ever comply with legal requires of the I.T Act. The borrower in its confirmation admitted that interest of rs.1,23,56,247/- was credited to the lender’s account but the payment actually made was only Rs. 2 lacs. Save and except that one payment, no other sums were paid. If the borrower actually credited interest to the appellant’s account in its books then u/s. 194A of the I T Act it had liability to deduct tax at source. Nothing was brought on record either by the AO or by the borrower which in any manner showed that as required by sec 194A, tax was deducted and paid to the credit of the Central Government in respect of the interest of Rs.1,23,56,247/- allegedly credited by the borrower in its books to the account of the appellant. Rather the information furnished by Guru Mehar Construction showed that save and except furnishing alleged confirmation of interest credited, the borrower did not comply with statutory requirements of Sec. 194A. On these facts therefore I am unable to uphold the AO’s order assessing interest income in AY 2009-10 simply on the basis of confirmation issued by the said borrower.

5.2.8 I also find force in the submissions of the A/R that even under mercantile system of accounting the entire interest for the defaulting period of more than one year could not be assessed as income of the appellant in one year. In percentage terms interest of Rs.1,23,56,247/- works out to be 89% of the total outstanding principal sum. This fact also supports the appellant’s plea that in reality no interest of Rs.1,23,56,247/- had accrued to the appellant in the FY 2008-09. Considering the totality of the facts and circumstances of the case, therefore, I hold that the AO was not justified in assessing Rs.1,23,56,247/- as interest income of the appellant chargeable in AY 2009-10. The AO shall however inform the assessing officer of Guru Mehar Construction regarding the fact that the M/s. Medpat Finance Limited 7 borrower credited appellant’s account with the entire arrear of interest in one year and claimed deduction for the same in one year which is contrary to law. The AO shall also inform the Assessing Officer of the borrower about default committed by the borrower of non deduction of Tax and its consequent effect u/s. 40(a)(ia) of the Act. These directions are issued to ensure that no leakage of revenue occurs as a consequence of the relief allowed to the appellant. “

3.3.3. In view of the undisputed factual findings with related legal position on the impugned issue , we find no infirmity in the order of the Learned CITA on this ground. Hence the ground no.2 raised by the revenue is dismissed.

4.1. The brief facts of this issue is that the Learned AO obtained information u/s 133(6) of the Act from Guru Mehar Construction wherein it was confirmed by the said party that the balance of hire purchase loan payable to assessee as on 1.4.2008 at Rs. 1,38,63,435/- . The Learned AO compared this balance with that appearing in the books of the assessee and found a difference of Rs. 8,21,143/- which he brought to tax as unexplained income of the assessee. On first appeal, the Learned CITA deleted the addition. Aggrieved, the revenue is in appeal before us on the following ground:- “ 3. That on the facts and circumstances of the case and in law, the ld.CIT(A) erred in deleting the addition of AO of Rs.8,21,143/- being accounting difference in the opening balance in the books of the assessee.”

M/s. Medpat Finance Limited 8 4.2. The Learned DR vehemently supported the order of the Learned AO and in response to this the Learned AR vehemently supported the order of the Learned CIT(A) and also held that in any case, there is no case for making an addition towards difference in the opening balance of loan figures as the same could be considered in the year in which the difference arose. He argued that Guru Mehar Construction had submitted the details of transactions to the Learned AO u/s 133(6) of the Act only in respect of Asst Year 2009-10 and not for the earlier years. Hence it is not possible to identify in which year the real difference in loan balance arose. In any case, he argued that there is no scope for making any addiiton in respect of opening balance difference and moreover, the Learned AO had not mentioned any section under which the said disallowance is contemplated by him.

4.3. We have heard the rival submissions and perused the materials available on record. We find that the Learned CITA had deleted the addition by making the following observations:- “ 5.3.1 I have considered the rival submissions. In the course of hearing the A/R filed year-wise summary of assessee’s aappellant’s transactions with Guru Mehar Construction for the period 01.04.2003 to 31.03.2009. From the said summary it appeared that sum outstanding and due from Guru Mehar Construction on 01.04.2008 was Rs. 1,30,42,291/- whereas as per the confirmation of the borrower it was Rs. 1,38,63,435/-. The addition in the impugned order was based solely on the confirmation of Guru Mehar and no other. Admittedly, the opening balance as on 01.04.2008 was the culmination of appellant’s transactions with Guru Mehar conducted till 31.03.2008. It was not a case where the transactions with the borrower commenced only in FY 2008-09 and in relation to these transactions discrepancies were found. In the circumstances I find force that the alleged accounting discrepancy as on 01.04.2008 did not emanate out of financial transactions carried out during the FY 2008-09. Although the AO did not specify the section of the I T Act under which the addition was made, yet the said addition was permissible only by way of unexplained investment u/s. 69 of the Act because the outstanding loan could only be considered as appellant’s “ investment” . However, in order to invoke Sec 69, it was necessary for the AO to prove that the alleged unexplained investment was made or acquired during the financial year

M/s. Medpat Finance Limited 9 relevant to AY 2009-10. By AO’s own admission the difference arose in the balance outstanding as at the beginning of the FY 2008-09. This balance was brought forward from 31.03.2008 meaning thereby the difference between the appellant’s books and the books of Guru Mehar Construction persisted in the earlier year. The accounting difference as per appellant’s books and as per borrower’s books did not emanate out of appellant’s transactions for the FY 2008-09. I also find force in the A/Rs submission that no information was gathered by the AO from Guru Mehar Construction with regard to its transactions with appellant in the year prior to FY 2008-09 even though the appellant had transactions with the said party earlier. The accounting difference as at the opening of the previous year was the culmination of the transactions conducted prior to 01.04.2008 and therefore addition if any could have been made only in the relevant years when the transactions giving rise to discrepancy actually took place. Although the AO alleged the appellant’s failure to furnish proper explanation for such accounting discrepancy yet I find that the AO himself did not obtain sufficient information from the borrower to enable the appellant to reconcile the difference in the opening balances. Considering the totality of the facts and having regard to language employed in Sec 69 of the I T Act. I find merit in the A/R’s submissions that the accounting difference in the outstanding balance brought forward from the earlier year did not represent unexplained investment of the FY 2008-09 and therefore could not be assessed as unexplained income of the appellant for the AY 2009-10. Accordingly addition of Rs. 8,21,143/- in AY 2009-10 is deleted. The AO shall however obtain the details of appellant’s year wise transactions from Guru Mehar Construction and provide opportunity to the appellant of reconciling the year wise balance and if the appellant is unable to explain the discrepancies then the AO shall make the addition in the year in which the discrepancy arises. Before doing so the AO shall grant adequate opportunity of hearing to the appellant. “

The factual findings recorded hereinabove have not been controverted by the Learned DR before us. We find lot of force in the argument of the Learned AR that even assuming that the difference in opening balance of loan figure is to be brought to tax, it cannot be added as income in the Asst Year 2009-10 and it should be considered only in the year in which the difference, if any, arose. We find from the details submitted by the said party i.e Guru Mehar Construction, that he had not submitted the transaction

M/s. Medpat Finance Limited 10 details prior to Asst Year 2009-10 and hence it is not clearly discernible from the records as to in which year the difference had arose. In view of this and in view of elaborate findings recorded by the Learned CITA , we find no reason to interfere with the order of the Learned CIT(A) in this regard. Accordingly, the ground no. 3 raised by the revenue is dismissed.