2018 (5) TMI 1433 - HC - Income Tax

High Court Upholds Cash Basis for Non-Performing Assets in Income Tax Appeal

The High Court dismissed the appeal by the Revenue under Section 260-A of the Income Tax Act, 1961, regarding the addition of interest on non-performing ... Recognition of income from non-performing assets on cash (receipt) basis - mercantile versus cash system of accounting - hybrid/mixed system of accounting and its effect on taxability of notional income - application of amended Section 145 requiring computation under cash or mercantile system subject to notified accounting standards - taxability of notional accruals where asset is classified as non-performingRecognition of income from non-performing assets on cash (receipt) basis - mercantile versus cash system of accounting - hybrid/mixed system of accounting and its effect on taxability of notional income - Whether interest on non-performing assets shown as accrued in accounts can be assessed on accrual basis despite the asset being classified as NPA and the assessee following a mercantile or mixed system of accounting. - HELD THAT: - The Court held that where an asset is demonstrated to be a non-performing asset, the statutory and accounting position is that such an asset has ceased to yield income and income from it should be recognised only when actually received. Relying on the decision in Canfin Homes Ltd., and having regard to the principles in the cited Supreme Court authorities, the Court rejected the Revenue's contention that accrual shown under a mercantile or hybrid system must be taxed notwithstanding NPA classification. The Tribunal correctly followed the jurisdictional High Court precedent that income from NPAs is to be assessed on a cash/receipt basis and that the mere showing of notional accrual in accounts does not justify bringing such notional income to tax where recovery is not possible and the asset has been declared non-performing. No contrary decision of the Supreme Court was shown, and the Tribunal was therefore entitled to uphold the deletion made by the CIT(A).The Tribunal's deletion of the addition of interest on NPAs was upheld; the interest on NPA is not taxable on accrual where the asset is a non-performing asset and income is to be recognised on actual receipt.Final Conclusion: The appeal is dismissed and the Tribunal's order deleting the addition in respect of interest on non-performing assets for Assessment Year 2010- 2011 is upheld. Issues:1. Appeal under Section 260-A of the Income Tax Act, 1961 against the order of the Income Tax Appellate Tribunal regarding interest on non-performing assets for the Assessment Year 2010-2011.2. Interpretation of Section 145 of the Act in relation to the computation of income under cash or mercantile system of accounting.3. Whether income from non-performing assets should be assessed on cash basis or mercantile basis.Analysis:The High Court of Karnataka heard an appeal by the Revenue under Section 260-A of the Income Tax Act, 1961 against the order of the Income Tax Appellate Tribunal regarding the addition of interest on non-performing assets (NPAs) for the Assessment Year 2010-2011. The respondent, a Co-operative Society engaged in banking business, had the addition deleted by the Commissioner of Income Tax (Appeals) following a previous decision of the Court. The Tribunal also dismissed the Revenue's appeal, citing that the Assessing Officer was not justified in taxing interest on NPAs on accrual basis due to the hybrid system of accounting used by the assessee. The Tribunal allowed all grounds in favor of the appellant, leading to the Revenue's appeal to the High Court.The Revenue contended that the matter was not considered fully by the Tribunal as the Hon'ble Supreme Court had dismissed a Special Leave Petition (SLP) in a related case but left the question of law open. The Revenue argued that under the amended Section 145 of the Act, income must be computed under cash or mercantile system of accounting, and in this case, non-accrual of income on NPAs following a mixed system of accounting was impermissible. However, the High Court found that the question of law was settled in a previous decision of the Court regarding the assessment of income from NPAs on cash basis even if the assessee followed a mercantile system of accounting.The High Court referred to previous decisions of the Hon'ble Supreme Court and held that if an assessee adopts the mercantile system of accounting and shows income as accruing, it is liable to be taxed, unless it is proven that the income cannot be recovered. In the case of non-performing assets, the income should only be recognized when actually received, as per policy guidelines. The Court emphasized that when an asset is classified as an NPA, it is assumed not to yield revenue, and thus, taxing notional income on NPAs under a mercantile system was baseless. As there was no contrary decision by the Supreme Court, the High Court upheld the previous decision and dismissed the appeal, stating that the Tribunal had not erred in approving the deletion of the addition in respect of interest on NPAs by the Commissioner of Income Tax (Appeals).In conclusion, the High Court dismissed the appeal, affirming the decision that income from NPAs should be assessed on cash basis, even if the assessee follows a mercantile system of accounting, based on previous rulings and policy guidelines.