2002 (12) TMI 56 - HC - Income Tax

Penal interest paid to the Reserve Bank of India - interest on sticky loans - the assessee has paid the penalty which it could have avoided by putting forth a plausible explanation before the concerned authority but the assessee obviously has suffered the penalty for want of a plausible explanation. - Tribunal is not correct in holding that penal interest paid to the Reserve Bank of India is not disallowable - Further, Tribunal is right in law in holding that the interest on sticky loans should be assessed on cash basis and not on accrual basis

Summary

Issues Involved:
1. Correctness of following the cash system of accounting for interest receivable on sticky loans while using the mercantile system for other receipts.
2. Assessment of interest on sticky loans on a cash basis versus accrual basis.
3. Deductibility of penal interest paid to the Reserve Bank of India.

Issue-wise Detailed Analysis:

1. Correctness of Following the Cash System of Accounting for Interest Receivable on Sticky Loans While Using the Mercantile System for Other Receipts:
The assessee, a nationalized bank, had been following the mercantile system of accounting for computing its profits but adopted the cash system for interest on sticky loans, which included suit filed accounts, claims lodged accounts, and accounts provided for bad and doubtful debts. The Tribunal found this hybrid system acceptable as it had been consistently followed for over 35 years and was recognized by the Department. The Tribunal held that the assessee was correct in following the cash system for interest on sticky loans, as the Department had not objected to this practice in the past and had accepted the returns filed based on this method.

2. Assessment of Interest on Sticky Loans on a Cash Basis Versus Accrual Basis:
The Tribunal held that the interest on sticky loans should be assessed on a cash basis and not on an accrual basis. The Revenue argued that the interest income on sticky loans had accrued and should be taxed accordingly, citing the Supreme Court decision in State Bank of Travancore v. CIT [1986] 158 ITR 102, which emphasized the concept of real income and accrual. However, the Tribunal noted that the assessee had been permitted to follow the cash system for such interest, and this method had been consistently accepted by the Department. The Tribunal distinguished the case from State Bank of Travancore, noting that the assessee had not made corresponding debit entries to the borrower's accounts, and the method of accounting had been approved by the High Court in earlier references.

3. Deductibility of Penal Interest Paid to the Reserve Bank of India:
The assessee paid penal interest amounting to Rs. 10,37,035 for not maintaining the statutory liquidity ratio as required under section 24 of the Banking Regulation Act, 1949. The Tribunal allowed this as a deductible expenditure under section 37 of the Income-tax Act, following its consistent practice for earlier years. The Revenue contended that this penal interest was a penalty for infraction of law and should not be deductible. The Tribunal, however, held that the penal interest was compensatory in nature and incidental to the business activities of the assessee. The Tribunal's decision was based on the fact that the assessee had been consistently allowed such deductions in the past, and the Revenue had not objected to this practice in earlier years.

Conclusion:
The Tribunal's decisions on all three issues were in favor of the assessee. The Tribunal upheld the hybrid system of accounting, allowing the cash system for interest on sticky loans and the mercantile system for other receipts. It also held that interest on sticky loans should be assessed on a cash basis and allowed the penal interest paid to the Reserve Bank of India as a deductible expenditure. The Tribunal's decisions were based on the consistent practice followed by the assessee and accepted by the Department over several years.