2014 (1) TMI 86 - HC - Income Tax

Taxability of interest on sticky loans - accrual of income - Held that - Following UCO Bank Vs. Commissioner of Income Tax 1999 (5) TMI 3 - SUPREME Court - Interest on Sticky Loans , recovery whereof is doubtful, if not shown in Profit and Loss Account should be treated as not forming part of the income of the assessee, irrespective of whether the assessee otherwise follows the mercantile system of accounting - Interest on loans and advances, of which recovery has become extremely doubtful, and which is written off for all practical purposes, but recorded separately, in the faint hope of recovery at some future point of time, does not come within the purview of chargeable interest within the meaning of Sections 5 and 6 of the Interest Act - As per the proviso to Section 5 of the Interest Act - Interest in relation to categories of bad or doubtful debts, referred to in Section 43D of the Income Tax Act, shall be deemed to accrue or arise in the previous year in which it is credited to the profit and loss account for that year - Non-operational sticky loans in respect of which mercantile actual of interest was shown in the suspense account and not the profit and loss account, would not, be payable on mercantile accrual basis - Interest on such loans would have to be accounted for and paid as and when it is realised - Decided in favour of assessee.

Issues Involved:
1. Taxability of interest on sticky loans under the Interest Act 1974.
2. Applicability of principles from the Income Tax Act to the Interest Act.
3. Basis of tax computation for sticky loans: mercantile accrual or actual receipt.

Detailed Analysis:

1. Taxability of Interest on Sticky Loans:
The primary issue is whether interest on sticky loans, which the Assessee Bank did not credit in its Profit and Loss Account due to the doubtful recovery, is liable to tax under the Interest Act 1974. The Assessee Bank follows a mixed system of accounting, mainly mercantile, but records interest on sticky loans on a realization basis, transferring such interest to a Suspense Account until 31st December 1980. Post-1981, the interest on sticky loans was not entered in the Books of Accounts but maintained as a memorandum. Tax was paid on such interest only upon actual realization.

2. Applicability of Principles from the Income Tax Act:
The court examined whether the principles applicable under the Income Tax Act concerning the computation of income from sticky loans apply to the Interest Act. It referred to the Supreme Court ruling in UCO Bank vs. Commissioner of Income Tax, which held that interest on sticky loans not brought to the profit and loss account but kept in a suspense account does not form part of the real income of the assessee bank. The Supreme Court approved the mixed system of accounting followed by the assessee bank, where interest on sticky loans was treated separately. This principle was affirmed in Mercantile Bank Ltd vs. Commissioner of Income Tax.

3. Basis of Tax Computation for Sticky Loans:
The court considered whether tax under the Interest Act should be computed on the basis of mercantile accrual or actual receipt of interest on sticky loans. Chargeable interest under the Interest Act is defined as the total amount of interest accruing or arising in the previous year, irrespective of actual receipt. However, the proviso to Section 5 of the Interest Act states that interest on bad or doubtful debts, as referred to in Section 43D of the Income Tax Act, shall be deemed to accrue only when credited to the profit and loss account. Therefore, if the interest on sticky loans is not credited in the profit and loss account due to doubtful recovery, it does not fall within the scope of chargeable interest under the Interest Act.

Judgment:
The court answered the questions of law in favor of the assessee:

1. Interest on sticky loans not credited in the profit and loss account is not taxable under the Interest Act.
2. The principle that no income tax is payable on the mercantile accrual of interest on sticky loans, as decided for the assessee, applies similarly under the Interest Act.
3. Tax on sticky loans under the Interest Act should be computed based on actual receipt of interest, not on mercantile accrual.

The appeal filed by the assessee was allowed, and the court directed that a photostat certified copy of the judgment be supplied to the learned advocates appearing for the parties expeditiously, subject to compliance with requisite formalities.

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