Unrealised Interest on NPA Accounts not taxable notionally on accrual basis-High Court

Unrealised Interest on NPA Accounts not taxable notionally on accrual basis. AO has to follow the RBI Directions under section 45Q of RBI Act as held by Supreme Court

The appellant Revenue had filed the instant appeal against the order of the Income Tax Appellate Tribunal (ITAT) in holding that interest accrued on NPA accounts brought to tax on account of notional interest was not justified.

ABCAUS Case Law Citation:
ABCAUS 2314 (2018) (05) HC

Important Case Laws Cited/relied upon by the parties:
Commissioner of Income Tax v. Vishisht Chay Vyapar Ltd. 330 ITR 440.
Southern Technologies v Jt. Commissioner of Income Tax 320 ITR 577

The respondent assessee was a Non-Banking Financial Company (NBFC). It had given Interest bearing loans/advances to three parties (debtors). The assessee had not received interest for more than six months from its said debtors. Being a NBFC, the assessee was bound by directions of the Reserve Bank of India (RBI) which required NBFCs to declare such advances as Non Performing Assets (NPA), when accrued interest on them is not paid by the debtor for six months, continuously.

The assessee therefore treated the advances to its debtors as NPA, and did not show interest income, which it said, was unrealizable. The Assessing Officer (AO), however, added interest as the assessee’s income holding that it had “accrued” to it even if it was actually unpaid as the assessee followed the mercantile system of accounting.

The CIT (A) affirmed the AO’s order. The ITAT deleted such interest income. Aggrieved the Revenue had filed the instant tax appeal before the Hon’ble High Court.

The Revenue contended that there was cross shareholding of three debtors which were given the credit facility which distinguished them from normal defaulting debtors. It was also submitted that the financial health of the three debtor companies was not essentially sound; furthermore, nearly 40% of the amounts advanced by the assessee were to the three companies. As such the revenue had a right to hold that the transactions were not at arms’s length and therefore, the explanation that the advances were NPAs could not be legitimately accepted.

The assesseee pointed out that the issue stands decided by the division bench of the High Court which had ruled that RBI’s prudential banking norms, embodied in its directions to banking and non banking entities, were as binding as accounting standards under Section 145 of the Income Tax Act, and reflection of income on notional basis, did not reflect the realistic assessment of real income. It was submitted that the Supreme Court approved the said judgment. Therefore, there was no infirmity in the tribunal’s reasoning, and that the revenue had accepted the treatment of such NPAs earlier, by the assessee.

The Hon’ble High Court observed that the division bench answered the question whether notional interest income on NPA Accounts though not received can still be considered as accrued under the provisions of Income Tax Act and was, therefore, exigible to tax, in the negative for following reasons:

(i) The debtor was facing winding up petitions which led to uncertainty as to recovery of interest. Even the principal amount itself had become doubtful to recover. In this scenario it was legitimate move to infer that interest income thereupon has not “accrued”.

(ii) The assessee company being NBFC was governed by the provisions of RBI Act. Interest income could not be said to have accrued to the assessee having regard to the provisions of section 45Q of the RBI and Prudential Norms issued by the RBI.

The Hon’ble High Court observed that the Division Bench had also applied the reasoning given by the Hon’ble Supreme Court which held that the Income Tax Act is a tax on “real income”. The Apex Court opined that the RBI directions have nothing to do with computation of taxable income. These Directions cannot overrule the “permissible deductions” or “their exclusion” under the IT Act. The Supreme Court stated that the inconsistency between these Directions and Companies Act is only in the matter of Income Recognition and presentation of Financial Statements. The Accounting Policies adopted by an NBFC cannot determine the taxable income. It is well settled that the Accounting Policies followed by a company can be changed unless the AO comes to the conclusion that such change would result in understatement of profits. With respect to “income recognition”, however, the AO has to follow the RBI Directions 1998 in view of Section 45Q of the RBI Act. Hence, as far as Income Recognition is concerned, Section 145 of the IT Act has no role to play in the present dispute.

The Hon’ble High Court opined that in the absence of any findings that the cross holdings of the debtor companies was the predominant or sole reasoning for the assessee’s inability to recover its dues, the case was covered by the decision of the division bench particularly in view of the Supreme Court’s ruling

Accordingly, the question of law was answered against the Revenue and the appeal was dismissed.

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