2004 (7) TMI 309 - AT - Income Tax

Method Of Accounting - Recognition of income from non-performing assets (NPAs) under the mercantile system of accounting - Inclusion of unpaid interest from Godavari Capital Limited in total income - legal expenses incurred for conducting legal proceedings against defaulting debtors. HELD THAT - On the issue of inclusion in total income being unpaid interest from Godavari Capital Limited the learned DR submitted that the letter at the paper book showing that there was a mutual settlement between the parties as per which the amount had been written off was not considered either by the Assessing Officer or by the CIT(A). Thus we deem it proper to set aside the issue to the file of the Assessing Officer for considering this document and disposing of the issue in accordance with law. The assessee had not debited the Legal Expenses amount of Rs. 21, 84, 000 to its profit and loss account. Under the method of accounting being regularly followed by the assessee this expenditure had not been considered as one which had accrued during the year. When we were dealing with recognition of income in the form of interest lease rental and finance charges on hire purchase agreement emphasis was laid on the accrual of the income based on the method of accounting regularly employed by the assessee. We have also held that the method of accounting was consistent and the conduct of the party in treating the income in a particular manner is a material evidence as to whether the income has accrued or not. When on the issue of recognition of income we have given emphasis to AS I concepts such as consistency prudence method of accounting etc. can it be said that when it comes to expenditure the method of accounting etc. has no relevance? We do not think so. The only issue in both these cases is as to what is the time of accrual . Applying the same principle to the accrual of expenditure we have necessarily to hold that the expenditure had not accrued to the assessee during the year based on the consistent method of accounting being followed by the assessee. Accrual of expenditure or income under the mercantile system cannot be different under the Income-tax Act and under the Companies Act. What has not accrued under the Companies Act cannot be said to have accrued under the Income-tax Act. The assessee had followed Accounting Standard I and found it prudent that no provision need be made under the mercantile system of accounting for this expenditure/liability during this particular assessment year. Thus as per the company s method of accounting this expenditure had not crystallized during the relevant previous year. We therefore uphold the contention of the revenue and dismiss this ground of appeal raised by the assessee by applying the same reasoning as we have adopted as to the time of accrual of income in the case of interest on N.P.As. The assessee may claim the expenditure as and when the expenditure crystallises as per the method of accounting regularly employed by him. In the result the appeal of the assessee is allowed in part.

Summary

Issues Involved:
1. Inclusion of unrealized finance charges, lease rentals, and interest in total income.
2. Inclusion of unpaid interest from Godavari Capital Limited in total income.
3. Disallowance of legal expenses incurred for conducting legal proceedings against defaulting debtors.

Summary:

1. Inclusion of Unrealized Finance Charges, Lease Rentals, and Interest in Total Income:
The assessee, a non-banking financial company (NBFC), followed the prudential norms prescribed by the Reserve Bank of India (RBI) for income recognition, which led to the non-inclusion of Rs. 1,23,59,180 in its total income. The Assessing Officer (AO) included this amount in the total income, arguing that income must be recognized on an accrual basis under the mercantile system of accounting. The CIT(A) upheld the AO's decision, referencing previous tribunal decisions that RBI norms do not override Income-tax Act provisions. The Tribunal, however, noted that the assessee consistently followed the RBI norms from the assessment year 1995-96 and that these norms are binding under section 45JA of the RBI Act. The Tribunal cited various judgments supporting the principle that income must be real and not hypothetical, and concluded that the method of accounting adopted by the assessee, which complied with RBI norms and was consistent with Accounting Standard I, should not be disturbed. The Tribunal thus deleted the addition of Rs. 1,23,59,180.

2. Inclusion of Unpaid Interest from Godavari Capital Limited in Total Income:
The AO included Rs. 2,47,123 as unpaid interest from Godavari Capital Limited in the total income, which the assessee claimed was settled in full and final settlement. The Tribunal set aside this issue to the AO for reconsideration, instructing the AO to verify the settlement document and dispose of the issue in accordance with the law.

3. Disallowance of Legal Expenses:
The assessee claimed Rs. 21,84,009 as legal expenses incurred for recovery of dues from defaulting debtors, which was not debited to the profit and loss account but carried forward in the respective debtors' accounts. The AO disallowed the claim, and the CIT(A) upheld the disallowance, stating that such expenses must be debited to the profit and loss account to be deductible under section 37(1). The Tribunal agreed with the revenue, emphasizing the consistency and prudence in accounting standards, and held that the expenditure had not crystallized during the relevant year as per the method of accounting regularly employed by the assessee. The Tribunal dismissed this ground of appeal, allowing the assessee to claim the expenditure when it crystallizes.

Conclusion:
The appeal was allowed in part, with the Tribunal deleting the addition of unrealized finance charges, lease rentals, and interest, setting aside the issue of unpaid interest from Godavari Capital Limited for reconsideration, and upholding the disallowance of legal expenses.