2016 (8) TMI 377 - HC - Income Tax

Determination of tax liability - Interest on non performing assets - whether non taxable on accrual basis looking to the guidelines of the Reserve Bank of India? - Held that - While determining the tax liability of an assessee, two factors would come into play. Firstly, the recognition of income in terms of the recognised accounting principles and after such income is recognised, the computation thereof, in terms of the provisions of the Income Tax Act, 1961. Insofar as the computation of taxability is concerned, the same is solely governed by the provisions of the Income Tax Act and the accounting principles have no role to play. However, recognition of income stands on a different footing. Insofar as income recognition is concerned, it would be the RBI Directions which would prevail in view of the provisions of section 45Q of the RBI Act and section 145 would have no role to play. Hence, the Assessing Officer has to follow the RBI Directions. The Assessing Officer has thereafter entered into a discussion on the provisions of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, which provides for enforcement of security interest of banks and financial institutions and has observed that in the instant case, no material has been brought on record by the assessee to prove its efforts made in a bid to recover such debts which are classified as NPA and other categories. The Assessing Officer has also entered into a discussion as regards the quality of management, etc., without even examining as to whether or not there was any probability of interest being received on the NPAs. Commissioner (Appeals) has placed reliance upon the decision of the Supreme Court in the case of Southern Technologies Limited (2010 (1) TMI 5 - SUPREME COURT OF INDIA ) and held that there is no merit in the contention of the assessee that under commercial accounting, interest on NPAs cannot be charged. On the question of applicability of the CBDT Circular dated 9.10.1984, the Commissioner (Appeals) held that the same would not be applicable for the reason that the provisions of section 43D of the Act are clear and cannot be overridden through delegated legislation viz. circulars and notifications. The Commissioner (Appeals) was further of the opinion that the statutory provisions were brought on the Act much later than the said circular (which was issued in 1984) and therefore the said circular would not have any effect or binding force upon the Assessing Officer. The view adopted by the Assessing Officer and the Commissioner (Appeals) is clearly contrary to the view expressed by this court hereinabove. The Tribunal was therefore, wholly justified in setting aside the order passed by the Commissioner (Appeals) confirming the assessment order.Appellate Tribunal is right in law and on facts in holding that interest on non performing assets is not taxable on accrual basis looking to the guidelines of the Reserve Bank of India Decided in favour of the assessee and against the revenue

Summary

Issues Involved:
1. Whether interest on non-performing assets (NPA) is taxable on an accrual basis as per the Income Tax Act, considering the guidelines of the Reserve Bank of India (RBI).

Analysis:

1. Facts and Background:
The appellant, a co-operative bank, filed its return for the assessment year 2010-11, declaring a total income of ?1,55,66,430/- without including interest income on NPAs, arguing that such interest was not realizable. The Assessing Officer added ?1,72,73,000/- to the total income, asserting that interest on NPAs had accrued under the mercantile system of accounting. The Commissioner (Appeals) upheld this addition, but the Income Tax Appellate Tribunal (ITAT) deleted it, prompting the revenue to appeal.

2. Appellant's Arguments:
The appellant argued that under sections 5 and 28 of the Income Tax Act, income accrues when it becomes legally recoverable, regardless of actual receipt. They contended that the RBI guidelines for accounting purposes should not affect taxability under the Income Tax Act. They relied on several Supreme Court judgments, including Tuticorin Alkali Chemicals and Fertilizers Limited v. Income-Tax Commissioner, and Southern Technologies Limited v. Joint Commissioner of Income-Tax, to argue that accounting principles cannot override the provisions of the Income Tax Act.

3. Respondent's Arguments:
The respondent argued that income should be real and not hypothetical, and under RBI guidelines, interest on NPAs is not recognized on an accrual basis due to the improbability of recovery. They cited section 45Q of the RBI Act, which gives RBI guidelines an overriding effect over other laws, including the Income Tax Act. They also referred to Supreme Court rulings in UCO Bank v. Commissioner of Income-Tax and Mercantile Bank Ltd. v. Commissioner of Income-tax, which supported the non-recognition of interest on NPAs until actual receipt.

4. Tribunal's Findings:
The Tribunal, relying on its previous decisions and the Supreme Court's judgment in Southern Technologies Limited, held that RBI guidelines on income recognition must be followed, and interest on NPAs should not be taxed on an accrual basis.

5. High Court's Analysis:
The court noted that the RBI guidelines, which the assessee is bound to follow, mandate that interest on NPAs should not be recognized on an accrual basis but only when actually received. This aligns with the theory of real income, which suggests that only real and notional income should be taxed. The court distinguished between income recognition and computation of income, stating that while the latter is governed by the Income Tax Act, the former is influenced by RBI guidelines due to section 45Q of the RBI Act.

6. Precedents and Legal Principles:
The court reviewed several precedents, including the Supreme Court's decisions in Southern Technologies Limited, UCO Bank, and Mercantile Bank Ltd., which supported the non-recognition of interest on NPAs on an accrual basis. The court agreed with the Delhi High Court's interpretation in Commissioner of Income-tax v. Vasisth Chay Vyapar Ltd., which held that RBI guidelines on income recognition should prevail over the mercantile system of accounting for tax purposes.

7. Conclusion:
The court concluded that the RBI guidelines, which mandate non-recognition of interest on NPAs on an accrual basis, should be followed. The Assessing Officer must adhere to these guidelines, and section 145 of the Income Tax Act has no role in income recognition in this context. Consequently, the Tribunal's decision to delete the addition of ?1,72,73,000/- was upheld, and the appeal was dismissed.