2010 (11) TMI 88 - HC - Income Tax

Income Mercantile system of accounting Non-Banking financial for more than six months Assessee bound by Reserve Bank of India directions to treat deposit as non-performing asset Interest does not accrue - question of law decided against the Revenue and in favour of the assessee Appeal dismissed

Summary

Issues Involved:
1. Whether the Income-tax Appellate Tribunal erred in law and on the merits by deleting the additions of income made as interest earned/accrued on the loan advanced to M/s. Shaw Wallace by considering the interest as doubtful and unrealizable.

Issue-wise Detailed Analysis:

1. Treatment of Interest on Non-Performing Assets (NPA):
The central issue revolves around whether the interest on inter-corporate deposits (ICD) advanced to M/s. Shaw Wallace, which became non-performing assets (NPA), should be recognized as income under the Income-tax Act, 1961, despite the non-receipt of such interest due to the debtor's financial difficulties.

2. Provisions of the Reserve Bank of India (RBI) Act vs. Income-tax Act:
The assessee, a non-banking financial company (NBFC), argued that as per the RBI Act and the Prudential Norms, the ICD had to be classified as NPA, and thus, the interest thereon should not be recognized as income. The Income-tax Appellate Tribunal accepted this view, holding that section 45Q of the RBI Act, which contains a non obstante clause, overrides the provisions of the Income-tax Act regarding income recognition.

3. Accrual of Income under the Income-tax Act:
The Revenue contended that under the mercantile system of accounting, which the assessee followed, income accrues when it is due, regardless of actual receipt. The Assessing Officer and the Commissioner of Income-tax (Appeals) held that the interest income had accrued to the assessee and should be taxed accordingly.

4. Real Income Theory:
The Tribunal's decision was supported by the theory of real income, which posits that income should only be recognized when it is reasonably certain to be collected. The assessee demonstrated that due to Shaw Wallace's adverse financial situation and ongoing winding-up petitions, the recovery of both principal and interest was highly uncertain.

5. Judicial Precedents:
The Tribunal and the assessee relied on several judicial precedents, including:
- Southern Technologies Ltd. v. Joint CIT [2010] 320 ITR 577 (SC): This case differentiated between permissible deductions under the Income-tax Act and income recognition principles under the RBI Act.
- TRO v. Custodian, Special Court Act, 1992 [2007] 293 ITR 369 (SC): Held that provisions with a non obstante clause in other enactments override the Income-tax Act.
- CIT v. Elgi Finance Ltd. [2007] 293 ITR 357 (Mad): Held that no interest could be said to have accrued on loans classified as NPAs.
- CIT v. Goyal M. G. Gases (P) Ltd. [2008] 303 ITR 159 (Delhi): Recognized that interest on sticky loans where recovery is doubtful does not accrue under the mercantile system.

6. Accounting Standards:
The assessee's accounting treatment was in line with Accounting Standard-9 (AS-9) of the Institute of Chartered Accountants of India (ICAI), which mandates revenue recognition only when it is reasonably certain that ultimate collection will be made.

7. Conclusion:
The court held that under the given circumstances, interest income had not accrued to the assessee under the provisions of the Income-tax Act, supported by the real income theory and the mandatory accounting standards. The Tribunal's decision to delete the additions of income made as interest earned/accrued on the loan advanced to M/s. Shaw Wallace was upheld. The appeals were dismissed, and the question of law was decided against the Revenue and in favor of the assessee.