By TIOL News Service:

AHEMDABAD, AUGUST 12, 2016: THE ISSUE IS - Whether interest income on NPA's can be taxed on accrual basis, by forming an opinion that the principle of revenue recognition is not governed by the RBI's Guidelines or Circulars. NO IS THE ANSWER.

Facts of the case:

The assessee, a co-operative bank, had filed its return for A.Y 2010-11 declaring total income of Rs.1,55,66,430/- wherein it did not show interest income on non-performing assets, as according to it, such interest was not realisable. The assessee furnished such details and stated that such interest was not charged as mandatorily stipulated under Income Recognition and Assets Classification Norms of the RBI. The assessee placed strong reliance upon the Master Circular issued by the RBI on income recognition, assets classification, provisioning and other related matters and stated that in compliance of the circular no interest had been charged by it on NPA. It was further the case of the assessee that the interest if charged on NPA would further enhance the NPAs as recovery of the NPA amount was itself not certain. The AO was of the view that the circular would not be applicable to the assessee as the same was applicable only to Banking Companies and the assessee was a co-operative bank and not a banking company. Further that all case law referred to by the assessee pertained to Non Banking Financial Institutions and scheduled banks whereas the assessee is a co-operative bank and as such both the institutions were differently governed by the RBI in terms of regulations. The AO held that the assessee should have offered the interest on the NPAs as income for the assessment year under consideration and that even if due to the prudential norms of the RBI Act, the bank did not recognise it as income for the particular financial year in which it accrued but offers the same on actual receipt, as a remedial measure, in order to comply with the provisions of the I-T Act. Accordingly, an addition of Rs.1,72,73,000/- came to be made to the total income of the assessee being the undisclosed income in form of accrued interest on non-performing assets.On appeal, the CIT(A) held that the CBDT Circular would not be applicable for the reason that the provisions of section 43D could not be overridden through delegated legislation viz. circulars and notifications. The CI(A) was further of the opinion that the statutory provisions were brought on the Act much later than the said circular and therefore the said circular would not have any effect or binding force upon the AO. He, accordingly, upheld the addition of Rs.1,72,73,000/- made by the AO on account of accrued interest on NPAs.

The High Court's holding:

1. There is no dispute that the RBI Guidelines are applicable to the assessee. It is the case of the assessee that in view of the RBI Guidelines, it cannot charge interest on accrual basis and that following the theory of real income, taxability of any notional income like accrued interest on NPAs would not arise. It has also been contended that even otherwise in view of the CBDT Circular bearing F No.201/21/84-ITA-II dated 09.10.1984, interest on accrual basis is not taxable if not received for three years even though credited to the suspense account. Thus, though the assessee follows the mercantile system of accounting, in terms of the RBI Guidelines which the assessee is bound to follow, certain assets were required to be declared as non-performing assets, accordingly, the income pertaining to such assets has not been considered as income by the assessee. In UCO Bank, Calcutta v. CIT, the Supreme Court was called upon to consider whether interest on a loan whose recovery is doubtful and which has not been recovered by the bank for the last three years but has been kept in a suspense account, can be included in the income of the bank for the A.Y 1981-82. The court observed that: "....The assessee's method of accounting, therefore, transferring the doubtful debt to an interest suspense account and not treating it as profit until actually received is in accordance with accounting practice. In the present case the method employed is entirely for a proper determination of income. The question whether interest earned, on what have come to be known as "sticky" loans, can be considered as income or not until actual realization, is a question which may arise before several ITOs exercising jurisdiction in different parts of the country. Under the accounting practice, interest which is transferred to the suspense account and not brought to the profit and loss account of the company is not treated as income. The question whether in a given case such "accrual" of interest is doubtful or not, may also be problematic. If, therefore, the Board has considered it necessary to lay down a general test for deciding what is a doubtful debt, and directed that all ITOs should treat such amounts as not forming part of the income of the assessee until realized, this direction by way of a circular cannot be considered as travelling beyond the powers of the Board u/s 119 of I-T Act. Such a circular is binding u/s 119. The circular of 9- 10-1984, therefore, provides a test for recognising whether a claim for interest can be treated as a doubtful claim unlikely to be recovered or not. The test provided by the said circular is to see whether at the end of three years, the amount of interest has, in fact, been recovered by the bank or not. If it is not recovered for a period of three years, then in the fourth year and onwards the claim for interest has to be treated as a doubtful claim which need not be included in the income of the assessee until it is actually recovered....";

2. In Southern Technologies Limited v. CIT, the Supreme Court was considering a case where categorisation of assets into doubtful, sub-standard and loss was not in dispute. On a close reading of the said decision, it appears that in the facts of the said case, the assessee, after making provision for NPA had sought deduction of such amount u/s 36(1)(vii) and alternatively claimed deduction u/s 37. Clearly, therefore, deduction was sought of an amount which was shown as income in the earlier years. In the present case, we are not concerned with any claim for deduction of provision made for NPA. It is the case of the assessee that in view of the income recognition norms laid down by the RBI, interest on NPA is not to be shown as income and is not to be charged to tax. Thus, this is a case of recognition of income u/s 145 and not a case of deduction under any provision of the Income Tax Act. Section 45Q finds place in Chapter IIIB of the RBI Act. Thus, the provisions of Chapter IIIB of the RBI Act have an overriding effect qua other enactments to the extent the same are inconsistent with the provisions contained therein. In order to reflect a bank's actual financial health in its balance sheet, the RBI has introduced prudential norms for income recognition, asset classification and provisioning for advances portfolio of the co-operative banks. The guidelines provided thereunder are mandatory and it is incumbent upon all cooperative banks to follow the same. Insofar as income recognition is concerned, the circular provides that the policy of income recognition has to be objective and based on the record of recovery. Income from NPAs is not recognised on accrual basis but is booked as income only when it is actually received. Therefore, banks should not take to income account interest on NPAs on accrual basis. Thus, in view of the mandate of the RBI Guidelines the assessee cannot recognise income from non-performing assets on accrual basis but can book such income only when it is actually received. Thus, this is a case where at the threshold, the assessee, in view of the RBI Guidelines, cannot recognise income from NPA on accrual basis. The Supreme Court in Southern Technologies Limited case, has held that the 1998 Directions are only disclosure norms and have nothing to do with computation of total income under I-T Act or with the accounting treatment. The 1998 Directions only lay down the manner of presentation of NPA provision in the balance sheet of an NBFC. Therefore, in terms of the above decision, where an assessee makes provision for NPA and seeks deduction of such amount u/s 36(1)(vii) or section 37, then in the computation of income, the RBI Guidelines would have no role to play, and hence, an add back. Insofar as income recognition is concerned, the Supreme Court has held that even the AO has to follow the RBI Directions, 1998 in view of section 45Q of RBI Act and that as far as income recognition is concerned, section 145 of Income Tax Act, has not role to play;

3. In the light of the above discussion what emerges is 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. In the light of the view adopted by the court, it is not necessary to enter into any detailed discussion as regards the applicability or otherwise of the CBDT Circular to the facts of the present case. The Supreme Court in UCO Bank, Calcutta v. CIT, has held that such circulars are not meant for contradicting or nullifying any provision of the statute. The court did not find any inconsistency or contradiction between the circular so issued and section 145 of Income Tax Act. In the aforesaid premises, until the circular is revoked, the same continues to be in force and the same having been issued to mitigate the hardships caused to the class of assessees covered by the circular, such assessees would be entitled to the benefit thereof. Merely because by virtue of the provisions of section 43D, a certain class of assessees is given benefit under the provisions of the I-T Act, it would not mean that the same would override the circular. The assessee being bound by the RBI Guidelines which are issued under the provisions of the RBI Act has not shown the interest on NPA as income. By virtue of the provisions of section 45Q of the RBI Act, the provisions of Chapter IIIB thereof have an overriding effect over other laws including the Income Tax Act, 1961. Therefore, notwithstanding the provisions of section 43D, since the provisions of section 45Q of the RBI Act have an overriding effect vis-à-vis income recognition principles in the Companies Act, the AO is bound to follow the RBI Directions so far as income recognition is concerned. The contention that the assessee cannot indirectly claim the benefit which would amount to a benefit similar to that u/s 43D of the Act, therefore, does not merit acceptance. It is seen that the AO has brushed aside the submission of assessee based upon the circular of 1984, on the ground that the same is applicable only to banking companies and not to cooperative banks, on a misconception of law that a cooperative bank is not a banking company;

4. It may be noted that the expression "banking company" has been defined u/s 5(c) of the Banking Regulation Act, 1949 to mean any company which transacts the business of banking in India. Section 2(i) of the RBI Act provides that "co-operative bank", "co-operative credit society", "director", "primary agricultural credit society", "primary co-operative society" and "primary credit society" shall have the meanings respectively assigned to them in Part V of the Banking Regulation Act, 1949. Evidently therefore, the expression "banking company" would take within its sweep a co-operative bank. The AO has thereafter entered into a discussion on the provisions of SARFAESI, 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 AO 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. The CIT(A) placed reliance upon the decision of the Supreme Court in the case of Southern Technologies Limited 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, the CIT(A) held that the same would not be applicable for the reason that the provisions of section 43D are clear and cannot be overridden through delegated legislation viz. circulars and notifications. The CIT(A) was further of the opinion that the statutory provisions were brought on the Act much later than the said circular and therefore the said circular would not have any effect or binding force upon the AO. The view adopted by the AO and the CIT(A) is clearly contrary to the view expressed by this court hereinabove.

(See 2016-TIOL-1729-HC-AHM-IT)