2022 (8) TMI 1012 - AT - Income Tax

Accrual of income - method of accounting to recognize the revenue - Addition made for excess interest spread ('EIS') income earned on assignment of receivables - accounting methodology of the assessee - HELD THAT - The undisputed facts that emerge are that the assessee has transferred certain pool of outstanding debts owned by it by way of absolute sale to SPV by receiving lump-sum purchase consideration which is equal to the book value of the pool of debts transferred by the assessee. The SPV funds the deal by issuing pass-through certificates to the beneficiaries which get return of approx. 7%. Thus, the assessee gets immediate recovery of the principal outstanding. These debts would generate interest income in the range of approx. 14% over their respective tenure. As per the terms of the agreement, the assessee would be entitled for excess interest spread (EIS) as generated from the debts over their tenure which is in the range of 4 years to 16 years. The assessee would collect the debts on due date and deposit the receivables in a separate Collection and Payout Account . The surplus generated by the SPV (which would be in range of 7% approx.) in this account would be distributed as per unique mechanism which is known as Waterfall mechanism . The assessee is following consistent method of accounting to recognize the revenue in this manner. Following this consistent method, the income on these transactions has been offered in subsequent years also. The income thus offered by the assessee is on the reasoning that interest spread pertains to future years and its accrual and receipt is contingent upon certain conditions which cannot be estimated on the date of agreement. The said treatment of EIS is stated to be in line with the prudential norms prescribed by RBI and the principles of prudence - similar practice is followed by the industry. Notably, if income is utilized as per the agreed waterfall mechanism, there would be situations where the residual EIS paid to assessee could be nil or significantly lesser or even higher (if shortfalls in previous months are collected in a subsequent month at one go) than the amounts which are set out in the schedule, wherein scheduled amounts are based on ideal cash flows. Further, the agreement provides that the schedule of investor payouts forming part of the agreement may be revised from time to time in accordance with the Transaction Documents whether on account of pre-payments, part payments or otherwise. Payout schedule is indicative in nature and may undergo alterations as per the provisions of the Deed. Accordingly, the time at which the residual EIS as receivable by the assessee would become determinate only on the day when the Trust is aware of the amounts which are credited in the Collection and Payout Account and the quantum of monies which have to be utilized for meeting any statutory dues of the Trust or the expenses due and payable by the Trust including fees and interest payable to the persons making available the External Credit Enhancement and also the quantum of monies which are required for meeting the overdue Pass Through certificate (PTC) Yield in respect of any shortfalls in Investor payouts in previous months. All these amounts could only be determined on each payout date. In the present case, the receipt of EIS is uncertain and the same may or may not accrue to the assessee over the terms of the loan. The same has already been noted by us in preceding paras 4.8 4.9 of the order. The assessee, following a consistent method of accounting, has offered EIS to tax on proportionate basis as and when they have accrued over the tenure of loan and the same has been accepted by revenue. The said methodology is in accordance with the RBI norms as well as AS-9 which provide that in case the revenue could not be measured with reasonable certainty, a suitable provision thereof should be made. However, in the present case, we find that EIS may not have even accrued to the assessee in future years and thus, no such provision could be made in this year. Therefore, keeping in view the principle of prudence as well as rule of consistency, no fault could be found with the accounting methodology adopted by the assessee to recognize the revenue under securitization transactions. AO has arrived at estimated income under such arrangement by applying the present value factor on future estimated earnings, the receipt of which was uncertain. We concur with the submissions of Ld. AR that such a methodology has not been recognized under Income Tax Act and only the real income has to be assessed to tax. Thus we direct Ld. AO to accept the accounting methodology of the assessee and delete the impugned addition. The corresponding ground thus raised stand allowed. Deduction of education cess - HELD THAT - This issue has now been settled by Finance Act, 2022 wherein amendment to Sec.40(a)(ii) has been brought retrospectively with effect from AY 2005-06 by way of insertion of Explanation-3 which read as Explanation 3-For the removal of doubts, it is hereby clarified that for the purposes of this sub-clause, the term tax shall include and shall be deemed to have always included any surcharge or cess, by whatever name called, on such tax; Considering the same, we would hold that no such deduction is available to the assessee. This ground stand dismissed.

Summary

Issues Involved:
1. Addition made for excess interest spread (EIS) income earned on assignment of receivables amounting to INR 58,60,53,473.
2. Allowability of Education Cess paid as an expenditure under section 37(1) of the Act.
3. Condonation of delay in filing the appeal.

Detailed Analysis:

1. Addition made for excess interest spread (EIS) income earned on assignment of receivables:

Assessment Proceedings:
The assessee, a non-banking finance company (NBFC), securitized its loan receivables and recognized interest spread over the tenure of the loans. The Assessing Officer (AO) added INR 58.60 Crores as the present value of EIS, asserting it should be taxed upfront in the year of securitization. The AO argued that the transaction was an outright sale, transferring all significant risks and rewards to the buyer, thus crystallizing the revenue in the year of sale. The AO computed the present value of future interest spread using a discount factor of 9.7%.

Appellate Proceedings:
The assessee contended that only real income should be taxed and that EIS should be recognized over the life of the underlying receivables. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, stating the transaction was an absolute sale, and the income could not be deferred.

Tribunal Findings:
The Tribunal noted that the assessee followed a consistent accounting method, recognizing EIS as it accrued over the loan tenure. The Tribunal found that the receipt of EIS was uncertain and contingent on future events, aligning with the prudential norms prescribed by RBI and the principles of prudence. The Tribunal concluded that only real income should be assessed to tax, and the AO's method of applying a present value factor on future earnings was not recognized under the Income Tax Act. Therefore, the Tribunal directed the AO to accept the assessee's accounting methodology and delete the addition.

2. Allowability of Education Cess paid as an expenditure under section 37(1) of the Act:

The assessee sought a deduction for education cess based on judicial pronouncements. However, the Tribunal noted that the Finance Act, 2022, retrospectively amended Sec.40(a)(ii) to include any surcharge or cess within the definition of "tax." Consequently, the Tribunal held that no deduction for education cess was available to the assessee and dismissed this ground.

3. Condonation of delay in filing the appeal:

The appeal was delayed by 176 days due to the nationwide lockdown arising from the Covid-19 pandemic. The Tribunal found the delay was due to unforeseen and unprecedented circumstances and was not deliberate. Therefore, the Tribunal condoned the delay and proceeded with the adjudication on merits.

Conclusion:

The appeal was partly allowed. The Tribunal directed the AO to delete the addition related to EIS and dismissed the ground regarding the deduction of education cess. The order was pronounced on 08th June, 2022.