1994 (1) TMI 117 - AT - Income Tax

Assessing Officer Assessment Year Bona Fide Cash System Hybrid System Interest On Sticky Loans Mercantile System

Issues Involved:
1. Taxability of interest on sticky loans for three banks: M/s. Vysya Bank Ltd., M/s. Syndicate Bank, and M/s. Canara Bank.
2. Validity of the hybrid system of accounting.
3. Bona fide nature of the change in the method of accounting by Vysya Bank.
4. Treatment of share-issue expenses.
5. Allocation of entertainment expenditure.
6. Disallowance under Rule 6D.
7. Deduction under Section 80G.
8. Taxability of underwriting commission and brokerage.
9. Treatment of cash payments to employees as perquisites under Section 40A(5).
10. Disallowance of penal interest paid to the Reserve Bank of India.

Detailed Analysis:

1. Taxability of Interest on Sticky Loans
The primary issue across all three banks was whether interest on sticky loans should be taxed. The Assessing Officers (AOs) added back interest on sticky loans based on the Supreme Court judgment in the case of State Bank of Travancore v. CIT, which mandated the taxability of accrued interest, even if credited to a suspense account. However, the CIT(A) deleted these additions, distinguishing the facts from the State Bank of Travancore case and holding that income should be taxed only when it is actually realized.

2. Validity of the Hybrid System of Accounting
The Department argued that the hybrid system of accounting, where banks follow a cash system for sticky loans and a mercantile system for other incomes, was not permissible. However, the Tribunal found that the hybrid system is valid if it accurately reflects the true income. The Tribunal noted that the RBI's directives supported this practice, and several High Court judgments recognized the hybrid system's validity.

3. Bona Fide Nature of the Change in Accounting Method by Vysya Bank
Vysya Bank changed its accounting method for sticky loans from mercantile to cash basis starting from the assessment year 1987-88. The Department questioned the bona fide nature of this change. The Tribunal, however, found the change bona fide, noting that it was in line with RBI directives and aimed at realistic profit determination. The Tribunal also cited the Allahabad High Court's decision in New Victoria Mills Co. Ltd. v. CIT, which allowed changes in accounting methods if they were bona fide and not casual.

4. Treatment of Share-Issue Expenses
The CIT(A) treated share-issue expenses as revenue expenses, contrary to the AO's classification as capital expenses. The Tribunal upheld the CIT(A)'s decision, citing various High Court judgments, including Hindustan Machine Tools Ltd. v. CIT, which treated such expenses as revenue in nature.

5. Allocation of Entertainment Expenditure
The CIT(A) allowed 50% of entertainment expenditure as attributable to the employees, following the Tribunal's consistent approach in similar cases. The Tribunal upheld this decision.

6. Disallowance under Rule 6D
For the assessment year 1987-88, the AO disallowed Rs. 59,925 under Rule 6D due to a lack of details. The CIT(A) deleted this disallowance, but the Tribunal reversed the CIT(A)'s order, restoring the disallowance due to the absence of required details. For the assessment year 1988-89, the Tribunal upheld the CIT(A)'s deletion of a Rs. 15,000 disallowance, as no provision was made.

7. Deduction under Section 80G
The CIT(A) directed the AO to verify receipts for donations and allow deductions under Section 80G. The Tribunal upheld this direction, assuming the AO would verify the existence of exemption certificates.

8. Taxability of Underwriting Commission and Brokerage
The CIT(A) held that underwriting commission and brokerage received by Syndicate Bank were not taxable. The Tribunal upheld this decision, following the Karnataka High Court's judgment in Syndicate Bank v. CIT.

9. Treatment of Cash Payments to Employees as Perquisites under Section 40A(5)
The CIT(A) directed the AO not to consider cash payments to employees as perquisites for disallowance under Section 40A(5). The Tribunal upheld this decision, following the Karnataka High Court's judgment in CIT v. Mysore Commercial Union Ltd.

10. Disallowance of Penal Interest Paid to the Reserve Bank of India
The CIT(A) deleted the disallowance of penal interest paid to the RBI. The Tribunal upheld this decision, following its earlier judgments in Syndicate Bank's cases for previous assessment years.

Conclusion
The appeals were dismissed except for the partial allowance in the case of Vysya Bank for the assessment year 1987-88, where the disallowance under Rule 6D was restored. The Tribunal validated the hybrid accounting system for sticky loans, upheld the bona fide nature of Vysya Bank's accounting change, and confirmed the CIT(A)'s decisions on share-issue expenses, entertainment expenditure, Section 80G deductions, underwriting commission, and brokerage, cash payments to employees, and penal interest paid to the RBI.

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