2017 (9) TMI 1745 - AT - Income Tax

Tribunal upholds CIT(A)'s decision on interest on NPAs under RBI guidelines

Dy. CIT Circle-6, Ludhiana Versus M/s The Ludhiana Central Co- Operative Bank Ltd.

The Tribunal upheld the CIT(A)'s decision to delete the addition of interest on non-performing assets (NPAs) based on the mercantile system of accounting. ... Income recognition - Accrual of income - Addition on account of interest accrued on non performing assets - year of taxation - Held that:- As decided in assessee's own case the argument of the learned D.R. that the assessee is following the mercantile system of accounting is also dismissed since this aspect has been dealt with by various High Courts referred to above wherein they have categorically held that even following the mercantile system of accounting the interest on NPA account cannot be said to have accrued in the impugned year since the recovery of the same was impossible and even otherwise for the purpose of Income Recognition the RBI Directions, 1998, had to be followed in view of section 45Q of the RBI Act. Applying the 'Real Income Theory', the prescribed Accounting Standard issued by ICAI on Revenue Recognition, AS-9, the accounting practise of the asseessee relating to interest on sticky loans and the RBI guidelines relating to accounting for interest on NPA's, it was held that such income was taxable in the year of receipt only, when its realisation becomes reasonably certain. No infirmity in the order of the CIT(A) holding the interest on NPA's as taxable in the year of receipt, so as to warrant interference. Issues Involved:1. Deletion of addition on account of interest on non-performing assets (NPAs) by CIT(A).2. Applicability of Supreme Court decision in the case of State Bank of Travancore.3. Relevance of RBI guidelines and Section 45Q of the RBI Act.4. Applicability of the decision in the case of Vasisth Chay Vyapar Ltd.5. Impact of the mercantile system of accounting on interest recognition for NPAs.Issue-Wise Detailed Analysis:1. Deletion of Addition on Account of Interest on NPAs by CIT(A):The primary issue in the appeal was the deletion of Rs. 2,67,88,000 by the CIT(A) on account of interest on loans categorized as NPAs. The Assessing Officer (AO) had added this amount based on the assessee's mercantile system of accounting, asserting that interest on NPAs should be included on an accrual basis.2. Applicability of Supreme Court Decision in the Case of State Bank of Travancore:The Revenue contended that the CIT(A) erred by ignoring the Supreme Court's decision in State Bank of Travancore (158 ITR 102). However, the Tribunal noted that this decision had been overruled by the Supreme Court in UCO Bank, Calcutta Vs. CIT, West Bengal (1999) 4 SCC 599. The UCO Bank case emphasized that interest on doubtful loans should be taxed on a receipt basis, aligning with the 'Real Income Theory' and relevant accounting standards.3. Relevance of RBI Guidelines and Section 45Q of the RBI Act:The Tribunal highlighted that various High Courts have held that Cooperative Banks must follow RBI guidelines for income recognition, which mandate that interest on NPAs should be recognized on a receipt basis. Section 45Q of the RBI Act gives these guidelines an overriding effect over other Acts, including the Income Tax Act. The Gujarat High Court in Pr.CIT-5 Vs. Shri Mahila Sewa Sahakari Bank Ltd. affirmed that the AO must follow RBI directions for income recognition, and Section 145 of the Income Tax Act has no role in this context.4. Applicability of the Decision in the Case of Vasisth Chay Vyapar Ltd.:The Tribunal rejected the Revenue's argument that the Delhi High Court's decision in Vasisth Chay Vyapar Ltd. (330 ITR 440) was not applicable because the assessee was a cooperative society, not an NBFC. The Tribunal cited the Gujarat High Court's decision in Shri Mahila Sewa Sahakari Bank Ltd., which applied the principles from Vasisth Chay Vyapar Ltd. to cooperative banks, reinforcing that RBI guidelines must be followed for income recognition.5. Impact of the Mercantile System of Accounting on Interest Recognition for NPAs:The Tribunal dismissed the Revenue's argument that the assessee's mercantile system of accounting necessitated the inclusion of interest on NPAs on an accrual basis. It was noted that various High Courts have ruled that even under the mercantile system, interest on NPAs cannot be considered accrued if recovery is doubtful. The RBI Directions, 1998, must be followed for income recognition, as mandated by Section 45Q of the RBI Act.Conclusion:The Tribunal found no infirmity in the CIT(A)'s order, which adhered to the principles established in previous judgments and RBI guidelines. Consequently, the appeal by the Revenue was dismissed, affirming that interest on NPAs should be taxed in the year of receipt.