2016 (9) TMI 1078 - HC - Income Tax

Taxability of Interest Payments in Co-operative Banks Clarified by Court

The Court ruled that interest paid to members of a Co-operative Bank above Rs. 10,000 is taxable, based on a Government circular and a Division Bench ... Deductibility of interest paid to members of a co-operative bank - Prospective application of amendment to tax-deduction obligation (effective 1 June 2015) - Deduction for gratuity under Section 37(1) and interaction with Section 36(1)(v), Section 40A(7) and Section 43B - Recognition of income from non-performing assets under the mercantile system of accounting - Asset classification and prudential norms for income recognition, provisioning and treatment of sub standard, doubtful and loss assetsDeductibility of interest paid to members of a co-operative bank - Prospective application of amendment to tax-deduction obligation (effective 1 June 2015) - Interest paid to members of a co-operative bank above Rs. 10,000/- and the obligation to deduct tax thereon. - HELD THAT: - The Court treated this question as settled by the Division Bench decision in ITA No.100116/2014 (Bagalkot District Central Co operative Bank) which, with reference to Government circular F.No.142/14/2015 TPL No.19/2015, held that the amendment to the law requiring co operative banks to deduct tax on interest on time deposits became effective prospectively from 1 June 2015. Consequently, co operative banks were not required to deduct tax on interest on time deposits paid or credited before 1 June 2015. In view of that circular and the Division Bench ruling, the substantial question does not survive for consideration in this appeal (para 2). [Paras 2]Question answered by reference to the earlier Division Bench decision: the amendment is prospective from 1 June 2015 and no addition arises for interest paid or credited before that date.Deduction for gratuity under Section 37(1) and interaction with Section 36(1)(v), Section 40A(7) and Section 43B - Whether gratuity payable to employees of the bank is allowable as a deduction. - HELD THAT: - The Tribunal's conclusion that the gratuity provision/payment is deductible was upheld in the light of precedents. The Court referred to the Division Bench decision in Chief Commissioner (Admn) and Another vs. Karnataka Electricity Board , which held that liability incurred pursuant to statutory requirement could be claimed under Section 37(1) even if it did not fall within Section 36(1)(iv), and that a prudent estimate of such liability was deductible. Similar High Court authorities were noted. The Court also recorded arguments about the effect of the substitution of Section 40A(7) (with effect from 1.4.2000) and the position under Section 43B that actual payment would secure deduction; but the determinative position adopted by the Court follows the accepted principle that where the conditions for Section 37(1) are satisfied (or payment is made within the ambit of Section 43B), the gratuity liability/payment is allowable (paras 3-4). [Paras 3, 4]Deduction for gratuity is allowable as recognised liability under Section 37(1) (and, where applicable, by actual payment under Section 43B), consistent with the cited authorities.Recognition of income from non-performing assets under the mercantile system of accounting - Asset classification and prudential norms for income recognition, provisioning and treatment of sub standard, doubtful and loss assets - Whether interest receivable from non performing assets, bad and doubtful debts (not reflected in profit and loss account) could be taxed or deducted. - HELD THAT: - The Court relied on its Division Bench decision in Commissioner of Income Tax and another vs. Canfin Homes Ltd. , which held that under mercantile accounting an item shown as accrued in accounts is taxable unless it is stated to be not recoverable; however, by definition a non performing asset (NPA) ceases to generate income and interest on such assets that is not recognised in accounts cannot be brought to tax. The prudential norms and the RBI classification (sub standard, doubtful, loss assets) were noted to show that NPAs encompass those categories; accordingly, income from NPAs should be recognised only when actually received and not merely on accrual, and the Tribunal's view was affirmed (para 5). [Paras 5]Interest on non performing assets is not to be brought to tax unless actually received; NPAs (including sub standard, doubtful and loss assets) are to be treated in accordance with prudential norms and income recognised on realisation.Final Conclusion: The substantial questions of law raised in this appeal are answered in accordance with the Division Bench decision in ITA No.200002/2015 and connected appeals (as elaborated above), and the appeal is disposed of accordingly. Issues:1. Taxability of interest paid to members of a Co-operative Bank above Rs. 10,000.2. Deductibility of gratuity payable to employees.3. Deductibility of interest receivable from non-performing assets, bad, and doubtful debts.Analysis:Issue 1:The Court referred to a circular of the Government of India and a Division Bench judgment in a related case to rule that interest paid to members of a Co-operative Bank above Rs. 10,000 should be added to tax. The circular clarified that the exemption from tax deduction on interest payments to members by a co-operative society does not apply to co-operative banks post an amendment effective from June 1, 2015. Therefore, the question of law regarding this issue was deemed settled.Issue 2:The Court cited precedents to address the deductibility of gratuity payable to employees. It discussed the interpretation of Section 36(1)(v) of the Income Tax Act and emphasized that even if a contribution does not fall under this section, the assessee can claim deduction under Section 37(1) if requirements are met. The Court highlighted cases where provisions for gratuity funds were allowed as deductions under Section 37. The discussion also touched upon amendments to Section 40(A)(7) and Section 43-B, clarifying the conditions for claiming deductions related to gratuity funds.Issue 3:Regarding the deductibility of interest receivable from non-performing assets, the Court referred to a judgment involving Canfin Homes Ltd. to explain the treatment of income under the mercantile system of accounting. It emphasized that income should be recognized only when actually received, especially in the case of non-performing assets. The Court elaborated on the definition of non-performing assets and asset classification norms, indicating that all categories of non-performing assets, including bad loans and doubtful debts, should be treated similarly for tax purposes. The decision in the referenced case was applied to answer the question on the deductibility of income from non-performing assets.In conclusion, the judgment in the referenced case, ITA No.200002/2015, provided guidance for resolving the substantial questions of law raised in the present appeal. The Court disposed of the appeal based on the decisions made in the connected appeals, ensuring consistency in the application of tax laws to the specific issues discussed in the judgment.