Introduction
1.1 In case of an assessee following Mercantile
System of Accounting [i.e. accrual basis of accounting], the taxability of
interest on ‘sticky loans’ or ‘doubtful advances’, not recognised as revenue in
the books of account , has been a matter of debate and litigation under the
Income-tax Act [ the Act] for a long time under different circumstances/
scenario.
1.2 In case of Banks, Non-Banking Financial
companies [NBFCs] etc., which are also engaged in the business of lending
money, the accounting treatment of Non-Performing Assets [NPAs] and interest
thereon is governed by the norms set by the Reserve Bank of India [RBI- RBI
norms]. Under such norms, such entities are required to make provisions for
NPAs and are also mandated to not to recognise the interest on such NPAs as
revenue in the accounts.
1.3 Subject to specific provisions in the Act,
the provision for such NPAs is not deductible in computing income under the
head “Profits and gains of business or profession’ [Business Income] in case of
such entities as held by the Apex Court in the case of Southern Technology
Ltd [(2010)- 320 ITR 577] – Southern Technology’s case. However, the
taxability of interest on such NPAs not recognised as revenue in the accounts
as per the RBI norms in case of NBFCs [which are not covered by section 43D]
has been a matter of debate and litigation as the same are not protected by the
provisions of section 43D of the Act
[applicable to Banks, Public Financial Institutions, Housing Finance Public
Companies etc] which effectively provides that such interest is taxable either
in the year of recognition in the accounts or in the year of actual receipt,
whichever is earlier. Co-operative Banks [ except in specified cases] are also
now covered within the scope of Sec 43D from assessment year 2018-19. The
Revenue, usually takes the view that such interest is taxable under the
Mercantile System of Accounting [Mercantile System] as income having accrued in
the relevant year on time basis, notwithstanding the fact that the principal
amount of loan itself is doubtful of recovery [i.e. NPA] and the NBFCs are
mandatorily required not to recognise such interest as revenue in the accounts
under the RBI norms. The Delhi High Court in the case of Vasisth Chay Vyapar
Ltd has taken a favourable view on this issue and similar view is also
taken in other cases by the High Courts [Mahila Seva Sahakari Bank Ltd
(2007) 395 ITR 324(Guj), Brahmaputra Capital & financial Services Ltd
(2011) 335 ITR 182 (Del), etc]. However, the Revenue is contesting this
view.
1.4 The issue referred to in para 1.3 above had
come-up before the Apex Court in the context of Delhi High Court judgment
referred to in para 1.3 above and other appeals filed by the Revenue involving
the similar issue and the issue is now decided by the Apex Court and therefore,
it is thought fit to consider the same in this column.
CIT
vs. Vasisth Chay Vyapar Ltd [(2011) 330 ITR 440 (Del)]
2.1 Before the Delhi High Court, various
appeals pertaining to different assessment years of the same assessee had
come-up involving common issue. In the above case, the assessee company was
NBFC and accordingly, was governed by the Directions of the RBI and was
required to follow the RBI norms.
2.2 In the above case, the brief facts were:
the assessee had advanced Inter Corporate Deposit (ICD) to Shaw Wallace Company
(SWC) and on account of default of the payment of interest by SWC, under the
RBI norms, the ICD had become NPA and was accordingly, treated as such by the
assessee. The interest income on the ICD was recognised on accrual basis and
offered to tax for the assessment years 1995-96, 1996-97. For the subsequent
years, the interest income on ICD was not recognised under the RBI norms and
the same was also not offered to tax. Factually, the interest on the ICD was
also not received until the assessment year 2006-07. The SWC was passing
through adverse financial crisis and winding up petitions were also pending
against the SWC in the court. As such, the recovery of the amount of ICD itself
was uncertain and substantially doubtful.
2.2.1 On the above facts, the Assessing Officer
(AO) took the view that the interest on ICD had accrued to the assessee under
the Mercantile System and accordingly, added to the income of the assessee. The
first Appellant Authority also affirmed the order of the AO. For this, the
Revenue held the view that: the provisions of the RBI Act, 1934 (RBI Act) read
with the NBFCs Prudential Norms. (Reserve Bank) Directions, 1998 (RBI norms)
can not override the provisions of the Act under which the amount of interest
was taxable as accrued under the Mercantile System and is accordingly, taxable
u/s. 5 of the Act; and as such, the interest in question is taxable in
respective years. When the matter came-up before the Tribunal, the view was
taken that the provisions of section 45Q of the RBI Act overrides the provisions of the Income-tax Act and
the action of the assessee not recognising income from ICD, following RBI
norms, was correct and in accordance with the law. Accordingly, the Tribunal held that in terms of section 145 of the
Act, no addition could be made in respect of such unrealised interest on the
ICD which was admittedly NPA.
2.3 Under the above mentioned circumstances,
the issue came-up before the Delhi High Court at the instance of the Revenue
viz. ‘whether the Tribunal erred in law and on the merits by deleting the
addition of income made as interest earned on the loan advanced to SWC by
considering the interest as doubtful and unrealisable.
2.3.1 On behalf of the Revenue, the views held by
the Revenue [referred to in para 2.2.1] was reiterated. It was also contended
that the liability under the Act is governed by the provisions of the Act and
merely because for accounting purposes, the assessee had to follow the RBI norms, it would not mean that the
assessee was not liable to show the interest income which had accrued to the
assessee under the Mercantile System and was exigible to tax under the Act. For
this, the reliance was placed on the judgment of the Apex Court in Southern
Technology’s case (supra) which, according to the Revenue, supports this
position.
2.3.2 On the other hand, on
behalf of the assessee, it was, inter-alia, contended that: as per the
provisions of section 45Q of the RBI Act
[which has non-obstante clause], interest income on such NPA is required to be
recognised as per the RBI norms and as held by the Apex Court in TRO vs
Custodian, Special Court Act. 1992 [(2007) 293 ITR 369] where an Act makes
provision with non-obstante clause that would override the provisions of all
other Acts; the chargeable Business Income has to be determined as per the
method of accounting consistently followed by the assessee; as per the relevant
provisions of Companies Act, as well as section 145 of the Act, it was incumbent upon the assessee to confirm to the
mandatory accounting method and follow those standards; the system of
accounting consistently followed by the assessee was in conformity with those
accounting standards which, inter-alia, provided not to recognise
interest on such NPA, in view of the uncertainty of ultimate collection due to
tight and precarious financial position of the borrower [i.e. SWC]. For this,
specific reference was also made to the Accounting Standard 9 [AS 9] issued by
the Institute of Chartered Accountants of India [ICAI]. Relying on certain
judgments of different High Courts [such as Elgi Finance Ltd [(2017) 293 ITR
357(Mad) etc], it was also further contended that the courts have held that
even under the Mercantile System, it is illusionary to take credit for interest
where the principal itself is doubtful of recovery. It is further contended
that the courts have also recognised the theory of ‘real income’ and held that
notwithstanding that the assessee may be following Mercantile System, the
assessee could only be taxed on ’real income’ and not on any
hypothetical/illusionary income. For this, reference was made to the judgments
of the Apex Court in the cases of UCO Bank [(1999) 237 ITR 889], Shoorji
Vallabhdas & Co [(1962) 46 ITR 144] and Godhra Electricity Co Ltd
[(1997) 225 ITR 746]. It was also pointed out that relying on this ‘real
income’ theory, the Delhi High Court has also held that interest on sticky
loans, where recovery of the principal was doubtful, could not be said to have
accrued even under the Mercantile System and accordingly, such notional
interest could not be taxed as income of the assessee. For this, reference was
made to the two judgments of the Delhi High Court viz. Goyal M. G, Gases (P)
Ltd [(2008) 303 ITR 159] and Eicher Ltd [(2010) 320 ITR 410]
2.4 After noting the facts of the case and
contentions raised on behalf of both the sides, the Court proceeded to decide
the issue. For this purpose, the Court first referred to the provisions of
section 45Q of the RBI Act [under the caption ‘Chapter III- B to override other
laws’] which effectively provides that the provisions of Chapter III-B shall
have effect notwithstanding anything inconsistent therewith contained in any
other law for the time being in force or any instrument having effect by virtue
of any such law. The Court then also noted as under (pg 448):
“It is not
in dispute that on the application of the aforesaid provisions of the RBI and
the directions, the ICD advanced to M/s. Shaw Wallace by the assessee herein
had become NPA. It is also not in dispute that the assessee–company being NBFC
is 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 ICD as income having regard to the recognized accounting principles. The
accounting principles which the assessee is indubitably bound to follow are
AS-9……”
2.4.1 The Court also noted the provisions of AS 9
contained in para 9 dealing with effect of uncertainty on revenue recognition.
2.4.2 The Court then noted that in the above
scenario, it has to examine the strength in the submission made on behalf of
the Revenue that whether it can still be held that the income in the form of
interest though not received had still accrued to the assessee under the
provisions of the Act and was therefore exigible to tax.
2.4.3 In the above background, the Court decided
to first consider the issue of taxability in the context of the Act and for
that purpose to examine whether, under the given circumstances, interest on ICD
has accrued to the assessee. In this context, after referring to the factual
position with regard to the ICD [referred to in para 2.2 above], the Court,
concluded as under (pg 449):
“…These
circumstances, led to an uncertainty in so far as recovery of interest was
concerned, as a result of the aforesaid precarious financial position of Shaw
Wallace. What to talk of interest, even the principal amount itself had become
doubtful to recover. In this scenario it was legitimate move to infer that
interest income thereupon has not “accrued”. We are in agreement with the
submission of Mr. Vohra on this count, supported by various decisions of
different High Courts including this court which has already been referred to
above.”
2.4.4 Having considered the position with regard
to accrual of interest under the Act as above, the Court further explained the
effect of RBI norms as under (pg 449):
” In the instant case, the assessee-company
being NBFC is governed by the provisions of the RBI Act. In such a case,
interest income cannot be said to have accrued to the assessee having regard to
the provisions of section 45Q of the RBI Act and Prudential Norms issued by the
RBI in exercise of its statutory powers. As per these norms, the ICD had become
NPA and on such NPA where the interest was not received and possibility of
recovery was almost nil, it could not be treated to have been accrued in favour
of the assessee.”
2.4.5 The
Court then noted the argument raised on behalf of the Revenue that the case of
the assessee was to be dealt with for the purpose of taxability under the
provisions of the Act and not under the RBI Act, which was concerned with the
accounting method that the assessee was supposed to follow and in that respect,
the reliance placed by the Revenue on the judgment of the Apex Court in Southern
Technology’s case (supra). In this context, the Court noted that, no doubt,
in the first blush, that judgment gives an indication that the Apex Court has
held that the RBI Act does not override the provisions of the Act. However, on
a closure examination in the context in which the issue had arisen before the
Apex Court and certain observations of the Apex Court in that case, shows that
this proposition advanced on behalf of the Revenue may not be entirely correct.
In that case, primarily the Apex Court was dealing with the issue of
deductibility of provisions for NPA as bad debt u/s. 37 (1)(vii) of the Act and
many of the observations of the Apex Court should be read in that context.
However, in that case itself, the Apex Court has made a distinction with regard
to ‘income recognition’ and held that income had to be recognized in terms of
RBI norms, even though the same deviated from Mercantile System and/or section
145 of the Act. In this context, the Court, inter-alia, noted the following
observations of the Apex Court in that case (pgs 451/452):
“At the
outset, we may state that the in essence RBI Directions 1998 are
prudential/provisioning norms issued by the RBI under Chapter III-B of the RBI
Act, 1934. These norms deal essentially with income recognition. They force the
NBFCs to disclose the amount of NPA in their financial accounts. They force the
NBFCs to reflect ‘true and correct’ profits. By virtue of section 45Q, an
overriding effect is given to the Directions 1998 vis-à-vis ‘income
recognition’ principles in the Companies Act, 1956. These Directions constitute
a code by itself. However, these Directions 1998 and the Income-tax Act operate
in different areas. These Directions 1998 have nothing to do with computation
of taxable income. These Directions cannot overrule the ‘permissible
deductions’ or ‘their exclusion’ under the Income-tax Act. The inconsistency
between these Directions and Companies Act is only in the matter of income
recognition and presentation of 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
Assessing Officer comes to the conclusion that such change would result in
understatement of profits. However, here is the case where the Assessing
Officer has to follow the RBI Directions 1998 in view of section 45Q of the RBI
Act. Hence, as far as income recognition is concerned, section 145 of the
Income-tax Act has no role to play in the present dispute. “
2.4.6 After referring to the above referred
observations of the Apex Court in Southern Technology’s case (supra) and
deciding the issue in favour of the assessee, the Court further stated as under
(pg 452):
“We have also noticed the other line of cases wherein the Supreme Court
itself has held that when there is a provision in other enactment which
contains a non obstante clause, that would override the provisions of the
Income-tax Act. TRO v. Custodian, Special Court Act, 1992 [2007] 293 ITR 369
(SC) is one such case apart from other cases of different High Courts. When the
judgment of the Supreme Court in Southern Technology [2010] 320 ITR 577 is read in manner we have
read, it becomes easy to reconcile the ratio of Southern Technology with TRO v. Custodian, Special Court Act,
[1992] [2007] 293 ITR 369 (SC). Thus viewed from any angle, the decision of the
Tribunal appears to be correct in law. The question of law is thus decided
against the Revenue and in favour of the assessee. As a result, all these appeals are
dismissed.”
CIT vs. Vasistha Chay Vyapar Ltd – [(2019) 410 ITR
244 (SC)]
3.1 At the instance of the Revenue, the above
judgment of the Delhi High Court came up for consideration before the Apex
Court [being Civil Appeal No 5811 of 2012]. Many other appeals [such as appeal
in the Mahila Seva Sahakari Bank Ltd [(2017) 395 ITR 324 (Guj), Brahmaputra
Capital & Financial Services Ltd (2011)335 ITR 182 (Del), etc]
involving similar issue filed by the Revenue were also simultaneously dealt with by the Apex Court while deciding
this common issue.
3.2 Having considered the judgments under
appeal, the Apex Court, agreed with the same and held as under (pg 246):
” Having
gone through the impugned judgment in the aforesaid appeals, we are of the view
that the consideration of the question has been given a full and meaningful reasoning
and we agree with the same.
As a result, all the aforesaid appeals are
dismissed. . . .”
Conclusion.
4.1 In view of the above judgment of the
Apex Court, affirming the judgment of Delhi High Court referred to in para 2
above and other similar judgments involving the same issue, the position is now
settled that interest on NPAs not recognised in the accounts following the RBI
norms cannot be taxed on the ground that the assessee is following Mercantile
System of accounting. The judgment also clearly supports the view that under
such circumstances, interest of NPAs cannot be said to have accrued and
accordingly, can not taxed by invoking the provisions of section 5 of the Act.
4.1.1 Apart from this, the judgment of Delhi High
Court referred to in para 2 above having been affirmed and in that judgment,
relying on the observations of the Apex Court in Southern Technology’s case
[referred to in para 2.4.5 read with the observations referred to para 2.4.6],
the Delhi High Court has, effectively, expressed the view that the provisions
of section 45Q of the RBI Act and the RBI norms override the provisions of the
Act in this respect, and therefore also, such interest on NPA is not taxable
under the Act. In this context, the subsequent judgment of the Punjab &
Haryana High Court in the case of Ludhiana Central Co-op Bank Ltd [(2009)410
ITR 72] is also useful in which the High Court, after considering these
judgments, has clearly taken a view that section 45Q of the RBI Act has overriding effect and therefore,
such interest cannot be held to have accrued under the Act.
4.1.2 In
cases not governed by the RBI norms also, the observations in the Delhi High
Court judgment [referred to in para 2.4.3 above] should be useful in cases of interest on ‘sticky loans’ not
recognised in accounts, if the principle amount of loan itself is genuinely
doubtful of recovery, particularly due to precarious financial condition of the
borrower.
Effect of ICDS
4.2 From the Asst. Year. 2017-18, Business
income and ‘Income from Other Sources’ [Other Income] is required to be
computed in accordance with the provisions made in Income Computation and
Disclosure Standards [ICDS] notified u/s. 145 (2) of the Act. ICDS IV [Revenue
Recognition] also deals with recognition of interest as revenue in para 8. In
this context, answer to question no 13, given in Circular No 10/2017, dtd
23/3/2017 issued by the CBDT is worth
noting and the same is reproduced hereunder:
Question 13:
The condition of reasonable certainty of ultimate collection is not laid down
for taxation of interest, royalty and dividend. Whether the taxpayer is obliged
to account for such income even when the collection thereof is uncertain?
Answer: As
a principle, interest accrues on time basis and royalty accrues on the basis of
contractual terms. Subsequent non recovery in either cases can be claimed as
deduction in view of amendment to Section 36 (1) (vii). Further, the provision
of the Act (e.g. Section 43D) shall prevail over the provisions of ICDS.
4.2.1 The validity of some of the provisions of
different ICDS was challenged before the Delhi High Court in the case of Chamber
of Tax Consultants vs. UOI [(2018) 400 ITR 178 – CTC’s case]. Many of these
provisions of ICDS were held to be ultra vires the Act by the High
Court. Most of these invalidated provisions have been re-validated with
retrospective effect by various amendments made by the Finance Act, 2018 with
which we are not concerned in this write-up.
4.2.2 One
of the items under challenge before the Delhi Court in CTC’s case (supra)
was para 8.1 of the ICDS IV [Revenue Recognition] which provides that interest
shall accrue on time basis to be determined in the specified manner. The main
contention against this provisions was that in case of NBFCs also the interest
would become taxable on this accrual basis, even though such interest is not
recoverable [i.e. because of NPA status of the loan]. The deduction, if any, in
respect of the same can be claimed only u/s. 36(1)(vii) in respect of such
interest [which become the debt] as bad debt in the year in which the amount of
such debt or part thereof becomes irrecoverable without recording the same in
the books
of account.
4.2.3 In
the above context, the counter affidavit filed by the Revenue was as follows
(pgs 211/212):
“The
petitioners completely ignore the fact that this very provision of the ICDS
have been given approval by the highest legislative body, i.e., Parliament by
making an amendment to section 36(1)(vii) of the Act with effect from April 1,
2016 by Finance Act, 2015. The petitioners for furthering their point have
erroneously mentioned that the second proviso to section 36(1)(vii) casts an
additional burden on the assessee to prove that the debt is established to have
become due. In fact, a provision which is for the benefit of the assessees is
being projected to be a provision which is against the interests of
the assessee.
The ICDS
does not in any way wish to alter the well laid down principles of real income
by the Hon’ble Supreme Court, but is actually ensuring that there is a trace
available of the income which is foregone on this concept. Therefore, if there
is an interest income which is not likely to be realized is written off by the
assessee in the very same year immediately on its recognition (and even without
passing through its books), then it would be first recognised as revenue and
then allowed as a deduction under section 36(1)(vii) of the Act, including in
the case of NBFCs. However, in this process, the tax Department would have
information about the income which is so written off and keep a track of the
said sum then realised. Therefore, there is no enlargement of scope of income
or any deviation from the principles laid down by the hon’ble Supreme Court.”
4.2.4 In
view of the above, the Delhi High Court in CTC’s case (supra), while
rejecting the contention raised on behalf of the Petitioner, concluded as under
on this issue (pg 212) :
“Since
there is no challenge to section 36(1)(vii), para 8(1) of ICDS IV cannot be
held to be ultra vires the Act. This is to create a mechanism of tracking
unrecognized interest amounts for future taxability, if so accrued. In fact the
practice of moving debts which the bank or NBFC considers irrecoverable to a
suspense account is a practice which makes the organizations lose track of the
same. The justification by the respondent clearly demonstrates that this is a
matter of a larger policy and has the backing of Parliament with the enactment
of section 36(1)(vii). The reasoning given by the respondent stands to logic.
It has not been demonstrated by the petitioner that para 8(1) of ICDS IV is
contrary to any judgment of the Supreme Court, or any other court.”
4.2.5 Since the Delhi High Court in CTC’s case (supra) accepted the justification of the Revenue,
more so due to amendment made in the provisions of section 36(1)(vii), the High
Court took the view that para 8.1 of ICDS IV cannot be held to be ultra vires
the Act and it has not been demonstrated by the Petitioners that para 8.1 of
ICDS IV is contrary to any judgment of the Apex Court, or any other court. In
view of this, there is no amendment in the Act in this respect and accordingly,
interest income should continue to be governed by this provision of the ICDS.
4.2.6 In view of the judgment of
the Apex Court [referred to in para 3 above] affirming the judgment of the
Delhi High Court [referred to in para 2 above], it is worth exploring to raise
a contention that the said para 8.1 of ICDS is now contrary to the judgment of
the Apex Court. Apart from this, such interest on NPAs cannot be regarded as
accrued as held by the Apex Court and therefore, such interest cannot be
treated as accrued on time basis as contemplated in the ICDS and cannot be
taxed. Additionally, such interest, arguably, can not be taxed also on the
ground that the provisions of RBI Act[ read with RBI norms]overrides the
provisions of the Act as mentioned in para 4.1.1 above. Also due to the fact that the counter affidavit
of the Revenue before the Delhi High Court in CTC’s case (supra)
[referred to in para 4.2.3 above] specifically states that ICDS does not in any
way wish to alter the well laid down principles of real income by the Apex
Court, but is actually ensuring that there is a trace available of the income,
which is foregone in this concept, arguably, applying the real income theory,
such interest income should also not be considered as taxable. This contention should also be available to
the cases referred to in para 4.1.2 above.It may also be noted that, in cases
where interest income is assessable as Other Income, there is no specific
provision to claim deduction of income assessed under ICDS on time basis when
it becomes irrecoverable and this fact has not been considered by the Delhi
High Court in CTC’s case (supra) while dealing with the issue relating
to the said para 8.1 of ICDS IV.
