2011 (8) TMI 178 - HC - Income Tax

Income from non-performing assets taxable only when actually received, not on accrual; s.36(1)(viii) reserve deduction upheld

Commissioner of Income-tax, Central Circle, Bangalore Versus Canfin Homes Ltd.

HC held for the assessee that income from non-performing assets should be recognized on a cash basis (only when actually received) rather than merely on ... Deduction u/s 36(1)(viii) - Business income Vs. Other sources - Whether income from non-performing assets should be assessed on cash basis and not on mercantile basis despite the assessee maintaining mercantile system of accounting? - HELD THAT:- This Court in the case of the very same assessee [2010 (7) TMI 971 - KARNATAKA HIGH COURT], held that in respect of any special reserve created by any financial corporation which is engaged in providing long term finance for industrial or agricultural development or infrastructure facility in India, an amount not exceeding 40 per cent of the total income computed before making any deduction under these clauses and Chapter VI-A carry to such reserve account - Decided in favor of the assessee Regarding method of accounting - it is clear the requirement of complying with cash or mercantile system of accounting is subject to the directions to be issued by the Central Government in the matter of accounting standards - Income from non-performing asset (NPA) may not be recognized merely on the basis of accrual. An asset becomes non-performing when it ceases to yield income - The income from NPAs, therefore, should be recognized only when it is actually received - it is clear, if an assessee adopts mercantile system of accounting and in his accounts he shows a particular income as accruing, whether that amount is really accrued or not is liable to bring the said income to tax - As is clear from the policy guidelines issued by the National Housing Bank, the income from non-performing asset should be recognised only when it is actually received - Decided in favor of the assessee Issues:1. Assessment of interest and dividend income under the head 'Business income' and deduction under section 36(1)(viii) of the Act.2. Assessment of income from non-performing assets on cash basis vs. mercantile basis.Analysis:Issue 1:The Court referred to a previous case involving the same assessee, where it was held that a special reserve created by a financial corporation should be deducted from the taxable income under the heading 'Profits and gains'. The Court emphasized that no deduction should be made under specific clauses and chapters before computing the total income. Therefore, the Court concluded that interest and dividend income should not be assessed under 'Business income' but under 'Income from other sources,' allowing the deduction under section 36(1)(viii) of the Act in favor of the assessee.Issue 2:Regarding the assessment of income from non-performing assets, the revenue contended that under section 145(2) of the Income-tax Act, income accrued from such assets, regardless of actual receipt, should be considered for tax payment if the assessee follows the mercantile system of accounting. The Court analyzed section 145, highlighting that compliance with cash or mercantile accounting systems is subject to accounting standards notified by the Central Government. The Court also referred to accounting standards emphasizing the recognition of income based on accrual and the guidelines issued by the National Housing Bank on non-performing assets. The Court cited precedents where the concept of real income was discussed, concluding that income from non-performing assets should only be recognized when actually received. Therefore, the Court ruled in favor of the assessee, stating that the revenue's contention to tax notionally accrued income from non-performing assets under the mercantile system was unfounded.In conclusion, the Court dismissed the appeal based on the detailed analysis and rulings on both substantial questions of law, affirming the decisions in favor of the assessee on both issues.