The Commissioner of Income Tax-III V. M/s.Vishwas Investments Pvt.Ltd,

ITTA/292/2012

AI Insights

The case revolves around the dispute concerning the recognition of interest income by a private limited company engaged in investment and lending, which operated as a Non-Banking Financial Company (NBFC). The company had its application for NBFC registration rejected by the RBI but continued to follow RBI guidelines in its accounting practices. The assessing officer had added the interest income to the company's taxable income for the assessment year 2004-05, which the company contested. The Income Tax Appellate Tribunal ruled in favor of the company, allowing the non-recognition of the interest income on an accrual basis, which was contested by the Revenue in the present appeal.

• Counselvise Citation: [2009] 140 COUNSELVISE.COM (IT) 719141 (HC-HYDERABAD)
• Appeal Type: Others
• Pronouncement Date: 02-04-2009
• Assessment Year: misc
• Other Referred Cases: TCI Finance Limited Vs. ACIT, UCO Bank Vs. CIT
• Laws Referred To: Income Tax Act, 1961
• Result in Favour of: Others
• Court: HIGH COURT
• Keywords: Accounting Standards; Cash system; Interest income; Mercantile system; NBFC; Prudent Accounting
• Section: 271(1)(c); 36(1)(vii); 145(1); 260-A

Judgement Text

"THE HON’BLE SRI JUSTICE GODA RAGHURAM AND THE HON’BLE SRI JUSTICE M.S. RAMACHANDRA RAO ITTA No.292 of 2012 JUDGMENT (Per Hon’ble Sri Justice M.S.Ramachandra Rao) This appeal is filed under Section 260-A of the Income Tax Act, 1961 (for short “the Act”) challenging the order dt.02-04-2009 in I.T.A.No.30/Hyd/08 of the Income Tax Appellate Tribunal, Hyderabad Bench-A, Hyderabad relating to the assessment year 2004- 05. 2. The respondent is a private company engaged in the business of investment and lending and operated as a Non-Banking Financial Company (for short “NBFC”) but its application for registration as a NBFC was rejected by the RBI. 3. For the above assessment year, the assessing officer by order dt. 29-11-2006 derecognized interest income of Rs.1,41,12,872/- and added the said amount to its income apart from initiating penalty proceedings under Section 271 (1) (c) of the Act. He rejected the respondent’s contention that there was no certainty in the ultimate realization of interest and accordingly wherever interest did not accrue to the assessee during the previous year, it has not been recognized by the respondent as income and not admitted any interest receivable. The assessing officer held that the respondent is bound to declare interest income whenever it accrued during the accounting year for tax purpose; that if the respondent was of the opinion that the interest is not realizable, the only course open for it is to write off the claim as unrealizable debt under Section 36 (1) (vii) of the Act; that the Central Government had notified the accounting standards to be followed by all the assessees following the mercantile system of accounting and once the income is recognized and accounted for on mercantile basis, there is no scope for the assessee to delete the same from the gross receipts; that amounts of such debts totaling to Rs.9,40,85,812/- were not written off in the books as on 31-03-2004 and instead of considering the same as bad debt and debiting to profit and loss account, the respondent had chosen to derecognize the interest receivable of Rs.1,41,12,872/-; that the onus of proving the non-recovery of interest is on the respondent; that the respondent has not established the non-recovery from all its debtors; and the failure on the part of the assessee to recover dues from the parties/its debtors cannot become a ground for derecognizing the income that accrues from such persons. 4. The respondent filed an appeal to the Commissioner of Income Tax (Appeals)-IV, Hyderabad against the said order inter alia contending that the assessing officer erred in noting that interest on loans which are not recoverable, accrued during the previous year in spite of the fact that according to the guidelines issued by the R.B.I. no such interest was accrued and that the assessing officer erred in making the above addition to its income without properly considering its explanation. It contended that it was not recognizing income from loans and advances based on prudent accounting policies and accounting standards issued by the Institute of Chartered Accountants of India as there was no reasonable certainty of ultimate realization of interest and therefore wherever the interest did not accrue to the appellant during the previous year, the same was not recognized as income and not admitted as interest receivable. It also relied upon the decision of the ITAT, Hyderabad Bench in the case of TCI Finance Limited Vs. ACIT (91 ITD 573) wherein it was held that the accounting policy adopted by the respondent in not recognizing the interest on NPAs is in accordance with the provisions of Section 145 and Section 28 of the Act. The appellate authority rejected the appeal relying upon the decision of his predecessor in the case of the respondent for the assessment year 2002-03 and held that the loans under reference were not written off as recoverable by the assessee under Section 36 (1) (vii) of the Act and therefore the assessing officer was justified in bringing to tax the interest income mentioned above pertaining to the so-called NPAs in terms of the provisions of the Act which was not offered for taxation by the respondent. It also held that the decision in TCI Finance’s case (mentioned supra) relied upon by the respondent was not applicable as the respondent’s application for registration as NBFC was rejected by the RBI. 5. Aggrieved thereby, the respondent filed ITA No.30/Hyd/2008 to the Income Tax Appellate Tribunal, Hyderabad Bench-“A”, Hyderabad. 6. The respondent contended that it was a company incorporated in 1989 for the purpose of investment and finance; that it had always accounted for its interest income on receipt basis from its inception; that in the notes on accounts, it had specifically mentioned that dividends and interests on loans and advances are accounted on actual receipt; that this was in accordance with RBI guidelines; that it was immaterial whether the respondent was granted registration as NBFC or not in order to follow the guidelines of the RBI; that in not recognizing the interest income, the respondent had followed the prudential norms issued by the RBI in its notification dt. 31-01-1998; that in the earlier years, the IT Department had accepted the stand of the respondent to include interest income in the total income on receipt basis; and therefore the respondent was justified in not including the interest income. 7. The Tribunal allowed the appeal by its order dt.02-04-2009 holding that whether assessee is registered as NBFC or not, it was a finance company; that registration may have been refused by RBI on any technical ground but the mere fact of non-registration did not permit the derecognition of the respondent as a finance company; that the core dispute is whether the respondent is justified in not recognizing its interest income on accrual basis; that the assessee in general followed the mercantile system of accounting but with regard to its interest income, it follows the cash system of accounting; that this was categorically stated in the notes to the accounts; that the Revenue did not dispute that the respondent had been following this system of accounting since its inception; that Section 145 (1) of the Act permits the assessee to compute its business income in accordance with either cash or mercantile system of accounting regularly employed by it; that the mere fact of the assessee following cash system for interest and dividend income and mercantile system for other incomes, does not mean that the assessee/respondent is following a hybrid system of accounting; that the assessing officer while reproducing the note on Revenue recognition given by the respondent in its accounts left out the words “however, dividends and interests on loans and advances is accounted on actual receipt and that the assessing officer had misdirected himself by referring to para 9 of Accounting Standards-II as given in 208 ITR (ST) 3; and therefore the respondent is justified in not recognizing its interest income on accrual basis. It also held that even if the assessee is not registered as NBFC, prudential norms prescribed by the RBI can be followed by it and the only difference is that if a company is registered as NBFC, it is mandatory to follow the norms prescribed by RBI but that it would not follow that unregistered finance company can be imprudent or that if they follow prudential norms even by adopting recognized systems for accounting, the same should not be accepted. It took notice of the fact that finance companies have to recognize the risky nature of their loan portfolio requiring caution in recognition of interest income; that cash system of accounting has been considered more suitable for money lending transactions by courts; that the decision in TCI Finance (mentioned supra) cannot be said to be inapplicable. It also rejected the contention of the Revenue that some of the parties are sound and that the onus of proving non-recovery of dues is on the assessee and held that firstly, the assessee is not claiming deduction of bad debts and need not be put to this test and also because the assessee is following the cash system of accounting for interest income. It also noted that the assessee had explained in its accounts that negotiations are going on with the debtors and that pending negotiations, no provisions for NPAs is made in the accounts and consequently, no provision is made for interest receivable and interest payable as it was a conscious business decision, and that recoverability of the debt does not depend merely on the financial soundness of the debtor but also on the willingness of the debtor. It also held that the stand of the respondent is in conformity with the circular of the CBDT dt.09-10-1984, that even though the circular was meant for banks, the principles laid down therein equally apply to the respondent which is also a finance company whose business is not materially different than that conducted by banks. It relied upon the decision of the Supreme Court in UCO Bank Vs. CIT[1] and held that the stand of the assessee in not recognizing the interest income on accrual basis is not inconsistent with the provisions of Section 145 of the Act. It therefore deleted the interest income from the total income of the assessee in the year under consideration. 8. Aggrieved thereby the present appeal is filed by the Revenue. 9. Heard Sri B.Narasimha Sarma, learned Standing Counsel for the appellant-Revenue at the stage of admission. 10. He contended that the order of the Tribunal is erroneous; that it had not appreciated the relevant material facts and reasons in the orders of the assessing officer and the appellate commissioner; that the assessee cannot be said to be following a recognized method of accounting in respect of derecognized interest income and that the stand of the assessee is not in conformity with the RBI guidelines particularly in the absence of a claim to write off the above interest income as bad debt under Section 36 (1) (vii) of the Act. 11. We are unable to appreciate the stand taken by the Revenue. 12. It is admitted that the respondent is a private limited which was engaged in the business of investment and lending, that it was operating as a NBFC since 1989 and although it had applied for registration with RBI in 1997, its application had been rejected. So it restricted its operations with a view to wind up its NBFC operations after recovery of loans and advances already given. While continuing its operations it was not recognizing income from loans and advances based on prudent accounting policies and accounting standards issued by the Institute of Chartered Accountants of India as there was no reasonable certainty of ultimate realization of interest. It followed mercantile system of accounting for other income but in respect of interest and dividend income, it was following the cash system of accounting since inception and this was specifically stated in the notes to the accounts. Under Section 145 (1) of the Act, the respondent has a choice to compute its business income in accordance with either cash or mercantile system of accounting and it has therefore rightly adopted cash system for interests and dividend income and mercantile system for other incomes. There is no change of accounting policy as presumed by the assessing officer and para 9 of Accounting Standards-II relied upon by the assessing officer does not apply in the present case. Even if the registration of the respondent as NBFC was refused by the RBI, it does not follow that the accounting system adopted by the respondent should not be accepted even if it is a recognized accounting system. As rightly held by the Tribunal, finance companies have to recognize the risky nature of their loan portfolio requiring caution in the recognition of interest income and cash system of accounting is suitable for money lending transactions. There is no necessity for the assessee to prove that the interest income is not recoverable because it has not written off the interest income under Section 36 (1) (vii) of the Act. As rightly held by the Tribunal it was a conscious business decision of the respondent to follow cash system of accounting with regard to interest and dividend income and this business decision cannot be questioned by the Revenue. We fully agree with the reasons given by the Tribunal in deleting the interest income from the total income of the assessee and accordingly uphold the same. We are of the view that no substantial question of law arises for consideration in this appeal. 13. Therefore the appeal is dismissed at the admission stage. No costs. ____________________________ JUSTICE GODA RAGHURAM ___________________________________ JUSTICE M.S. RAMACHANDRA RAO DT: 10-12-2012 kvr [1] (1999) 237 ITR 889 (SC) "