2018 (11) TMI 442 - HC - Income Tax

Court rules interest on NPAs of Cooperative Banks taxable on receipt basis aligning with RBI guidelines & 'real income' theory.

The court dismissed the appeals, ruling in favor of the assessee-Cooperative Banks. It upheld that interest on Non-Performing Assets (NPAs) should be ... Interest accrued on NPA - Addition on account of interest accrued on non-performing assets - whether non-performing assets in the hands of the assessee- Cooperative Banks is taxable on accrual basis or not? - Held that:- The assessee being bound by the RBI Guidelines which are issued under the provisions of the 1934 Act has not shown the interest on NPA as income. By virtue of the provisions of section 45Q of the 1934 Act, the provisions of Chapter IIIB thereof have an overriding effect over other laws. Therefore, notwithstanding the provisions of section 43D of the Act, since the provisions of section 45Q of the 1934 Act have an overriding effect vis-à-vis income recognition principles in the Companies Act, the Assessing Officer is bound to follow the RBI Directions so far as income recognition is concerned. The interest on principal loan amount which has been classified as NPA cannot be held to have “accrued” so as to tax them under the Act. The contention that the assessee cannot indirectly claim the benefit which would amount to a benefit similar to that under section 43D of the Act, therefore, does not merit acceptance. Tribunal while relying upon the various pronouncements had decided the issue regarding taxability of interest on NPA's in favour of the assessee as being taxable in the year of receipt. The Tribunal had upheld the deletion made by the CIT(A) on account of addition regarding interest accrued on NPA. No illegality or perversity could be demonstrated by learned counsel for the revenue in the aforesaid findings recorded by the Tribunal. - Decided against revenue Issues Involved:1. Taxability of interest accrued on Non-Performing Assets (NPA) for Cooperative Banks.2. Applicability of Section 43D of the Income Tax Act to Cooperative Banks.3. Overriding effect of RBI guidelines under Section 45Q of the RBI Act, 1934 on income recognition.4. Application of the 'real income' theory in the context of NPAs.5. Relevance of Supreme Court decisions and CBDT circulars on interest recognition for NPAs.Issue-wise Analysis:1. Taxability of Interest Accrued on NPAs:The core issue was whether interest on NPAs in the hands of the assessee-Cooperative Banks is taxable on an accrual basis, considering RBI guidelines. The Tribunal upheld the deletion of the addition made by the Assessing Officer, ruling that interest on NPAs should be taxed on a receipt basis, not on an accrual basis, aligning with RBI guidelines.2. Applicability of Section 43D of the Income Tax Act to Cooperative Banks:Section 43D, inserted by Finance (No.2) Act 1991 and substituted by Finance Act, 1999, allows for the taxation of interest on bad or doubtful debts in the year of receipt for specified entities. The revenue argued that Cooperative Banks are not covered under Section 43D. However, the court noted that the benefit claimed by the assessee was not under Section 43D but due to RBI guidelines, which have an overriding effect under Section 45Q of the RBI Act, 1934.3. Overriding Effect of RBI Guidelines:Section 45Q of the RBI Act, 1934, stipulates that provisions under Chapter III-B override other laws. RBI guidelines mandate that interest on NPAs should not be recognized on an accrual basis but only when actually received. The court held that these guidelines override the provisions of the Income Tax Act concerning income recognition, reinforcing that interest on NPAs cannot be taxed on an accrual basis.4. Application of the 'Real Income' Theory:The 'real income' theory, supported by the Supreme Court in Southern Technologies Limited v. Joint CIT, emphasizes that income must be real and not hypothetical. The court reiterated that taxing interest on NPAs, which are unlikely to be recovered, would result in taxing hypothetical income. The Delhi High Court in Vasisth Chay Vyapar Ltd. also supported this view, stating that interest on NPAs should not be considered accrued income due to the uncertainty of recovery.5. Relevance of Supreme Court Decisions and CBDT Circulars:The revenue relied on the Supreme Court decision in State Bank of Travancore v. CIT, which held that once income accrues, it cannot be defeated by the theory of real income. However, the court distinguished this case, noting that subsequent decisions, including UCO Bank v. CIT, clarified the applicability of CBDT circulars and recognized the concept of real income. The court also noted that the Parliament amended Section 43D to include Cooperative Banks from 1.4.2018, indicating legislative intent to address this issue.Conclusion:The appeals were dismissed, and the substantial questions of law were answered in favor of the assessee. The court upheld the Tribunal's decision that interest on NPAs for Cooperative Banks should be taxed on a receipt basis, aligning with RBI guidelines and the 'real income' theory. The overriding effect of RBI guidelines under Section 45Q of the RBI Act, 1934, was affirmed, and the applicability of Section 43D was clarified in the context of the legislative amendment effective from 1.4.2018.