2018 (2) TMI 263 - AT - Income Tax

Applicability of Section 43D - non applicability in case of the assessee bank as it is not a scheduled bank as classified to this effect by the Reserve Bank of India - Held that - We find no merit in Revenue s instant argument. Learned AR quotes before us judgment of PCIT vs. Shri Mahila Seva Sahakari Bank Ltd. (2016 (8) TMI 377 - GUJARAT HIGH COURT) upholding that once the assessee bank had not recognized any income as per RBI guidelines issued u/s.45Q of the Reserve Bank of India Act, 1934, provisions of Chapter III thereof would have an overriding effect over all other laws including the Income Tax Act, 1961. Hon ble jurisdictional high court therefore has rejected Revenue s twin identical arguments therein (supra) as adopted by the Assessing Officer whilst making the impugned addition in the instant case. We make it clear that the Revenue has not drawn any distinction on facts or law qua the above hon ble jurisdictional high court s judgment. We therefore see no reason to interfere with the learned CIT(A) s order deleting the impugned addition. - Decided in favour of assessee

Issues Involved:
1. Applicability of Section 43D of the Income Tax Act, 1961 to a non-scheduled bank.
2. Accrual of interest on Non-Performing Assets (NPAs) under mercantile system of accounting.
3. Relevance of RBI guidelines and the concept of real income theory in recognizing interest income on NPAs.

Detailed Analysis:

1. Applicability of Section 43D of the Income Tax Act, 1961 to a non-scheduled bank:
The Assessing Officer (AO) argued that Section 43D of the Income Tax Act, 1961, read with Rule 6EA, does not apply to the assessee bank as it is not classified as a scheduled bank by the Reserve Bank of India (RBI). Consequently, the AO concluded that the interest on NPAs should be recognized on an accrual basis, leading to the addition of ?83,45,400/- to the assessee's income. However, the CIT(A) and various judicial precedents have established that Section 43D is not applicable to non-scheduled banks and that interest on NPAs should not be taxed on an accrual basis if it is not credited to the Profit and Loss (P&L) account.

2. Accrual of interest on Non-Performing Assets (NPAs) under mercantile system of accounting:
The AO contended that since the assessee bank follows the mercantile system of accounting, interest on NPAs should be accrued and taxed. The AO relied on the Supreme Court judgment in State Bank of Travancore vs. CIT, which supported the accrual of interest on NPAs. However, the CIT(A) and subsequent judicial decisions, including the Supreme Court's ruling in UCO Bank vs. CIT, have clarified that interest on NPAs should not be accrued if the recovery of the principal amount itself is doubtful. The real income theory supports that income should only be recognized when there is a reasonable certainty of its realization.

3. Relevance of RBI guidelines and the concept of real income theory in recognizing interest income on NPAs:
The RBI guidelines mandate that interest on NPAs should not be recognized on an accrual basis but only when it is actually received. The CIT(A) observed that the appellant bank followed these guidelines, which are binding and have an overriding effect over other laws, including the Income Tax Act, as per Section 45Q of the RBI Act. The CIT(A) and various judicial precedents, including the Bombay High Court in CIT vs. Devgiri Nagrik Sahakari Bank Ltd., have upheld that interest on NPAs should not be taxed on an accrual basis, aligning with the real income theory. The Supreme Court in UCO Bank vs. CIT also supported this view, emphasizing that notional interest on sticky loans should not be taxed.

Conclusion:
The Tribunal upheld the CIT(A)'s order, agreeing that the interest on NPAs should not be taxed on an accrual basis, as per the RBI guidelines and the real income theory. The Tribunal dismissed the Revenue's appeal, reinforcing that the provisions of the RBI Act have an overriding effect, and the assessee bank's method of not recognizing interest on NPAs until actually received is justified. The judgment aligns with various judicial precedents, including the Supreme Court's ruling in UCO Bank vs. CIT and the Bombay High Court's decision in CIT vs. Devgiri Nagrik Sahakari Bank Ltd.

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