1999 (5) TMI 3 - SC - Income Tax

Taxing unrealised interest on 'sticky' bank loans kept in suspense account-CBDT s119 circulars upheld; no income until recovery.

Whether interest on doubtful 'sticky' loans kept in a suspense account, not credited to the profit and loss account, could be taxed as income turned on ... Interest on loans advanced - suspense account - Effect and binding nature of the Central Board of Direct Taxes (CBDT) circulars u/s 119 - erroneous and prejudicial to the interests of the Revenue - Whether interest on a loan whose recovery is doubtful and which has not been recovered by the assessee-bank for the last three years but has been kept in a suspense account and has not been brought to the profit and loss account of the assessee, can be included in the income of the assessee for the assessment year 1981-82. - HELD THAT:- It is the case of the assessee that in respect of loans which are advanced by it to various customers, recovery of some loans is very doubtful. It is doubtful whether even the interest on the loans advanced will be recovered from the customer. In such cases, the interest calculated on the loan amount is credited in a suspense account. This amount is not brought to the profit and loss account of the assessee-bank because these are amounts which are not likely to be realised by the bank. Hence, they do not form a part of the real income of the bank. If and when any such amount or a part of it is recovered, it is included in that assessment year in the total income of the assessee for the purpose of payment of income-tax. The circular clarifies the way in which these amounts are to be treated under the accounting practice followed by the lender. The circular, therefore, cannot be treated as contrary to section 145 of the Income-tax Act or illegal in any form. It is meant for a uniform administration of law by all the income-tax authorities in a specific situation and, therefore, validly issued under section 119 of the Income-tax Act. As such, the circular would be binding on the Department. This court in Kerala Financial Corporation [1994 (5) TMI 2 - SUPREME COURT], where this court, following the majority view in State Bank of Travancore [1986 (1) TMI 1 - SUPREME COURT], held that interest which had accrued on a 'sticky' advance has to be treated as income of the assessee and taxable as such. It is said that ultimately, if the advance takes the shape of a bad debt, refund of the tax paid on the interest would become due and the same can be claimed by the assessee in accordance with law. Thus, we are not in agreement with the said judgment. The relevant circulars of the Central Board of Direct Taxes cannot be ignored. The question is not whether a circular can override or detract from the provisions of the Act ; the question is whether the circular seeks to mitigate the rigour of a particular section for the benefit of the assessee in certain specified circumstances. So long as such a circular is in force it would be binding on the departmental authorities in view of the provisions of section 119 to ensure a uniform and proper administration and application of the Income-tax Act. The appeal is, therefore, allowed and the question is answered in favour of the assessee and against the Department. Issues Involved:1. Whether interest on a loan whose recovery is doubtful and has not been recovered for three years, but kept in a suspense account, can be included in the income of the assessee.2. The status and binding nature of the Central Board of Direct Taxes (CBDT) circulars under Section 119 of the Income-tax Act, 1961.3. The applicability of CBDT circulars to banking companies and public financial institutions.4. The interpretation and application of Section 145 of the Income-tax Act regarding the method of accounting and income computation.Issue-wise Detailed Analysis:1. Interest on Doubtful Loans:The primary issue was whether the interest on loans, whose recovery was doubtful and had not been recovered for three years, should be included in the income of the assessee bank. The assessee, United Commercial Bank Ltd., had credited such interest to a suspense account and excluded it from its total income. The Income-tax Department initially accepted this exclusion based on the CBDT Circular No. F. 201/21 of 1984 ITA-II, dated October 9, 1984. However, the Commissioner of Income-tax later included this amount in the total income, considering the exclusion erroneous and prejudicial to the interests of the Revenue. The Tribunal allowed the assessee's appeal, but the High Court ruled in favor of the Revenue, citing the Supreme Court decision in State Bank of Travancore v. CIT [1986] 158 ITR 102.The Supreme Court had to determine if the interest on doubtful loans, kept in a suspense account and not brought to the profit and loss account, should be considered part of the real income of the bank. The Court noted that the assessee followed a mixed method of accounting, treating such interest as income only when realized, which aligned with accounting practices. The Court referenced authoritative texts like Spicer and Pegler's Practical Auditing and Shukla and Grewal on Advanced Accounts, which supported the practice of not treating doubtful interest as profit until received.2. Status and Binding Nature of CBDT Circulars:The Court examined the status of CBDT circulars under Section 119 of the Income-tax Act, which allows the CBDT to issue orders, instructions, and directions for the proper administration of the Act. Such circulars are binding on the authorities and cannot be adverse to the assessee. The Court emphasized that these circulars are meant to ensure fair enforcement of the law and mitigate undue hardship to the assessee. The Court highlighted that the CBDT circulars, including the one dated October 9, 1984, which provided a test for recognizing doubtful claims, were binding and validly issued under Section 119.3. Applicability of CBDT Circulars:The Court noted that the circular of October 9, 1984, applied to banking companies, specifying that interest on doubtful debts credited to a suspense account would not be taxed if not recovered for three consecutive years. This circular was applicable from the assessment year 1979-80 onwards. For the assessment years 1972-73 to 1976-77, the circular of October 6, 1952, was applicable, which also provided relief for interest on doubtful loans for money-lenders and was binding on the assessing authorities.4. Interpretation and Application of Section 145:The Court discussed Section 145 of the Income-tax Act, which mandates that income chargeable under the head 'Profit and gains of business or profession' or 'income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee. The Court recognized that the assessee's method of accounting, which excluded doubtful interest from the profit and loss account, was in accordance with accounting practices and did not contradict Section 145. The Court held that the CBDT circulars were consistent with Section 145 and were meant to ensure uniform administration of the law.Conclusion:The Supreme Court allowed the appeal, ruling in favor of the assessee and against the Department. The Court held that the interest on doubtful loans, kept in a suspense account and not brought to the profit and loss account, should not be included in the income of the assessee until actually received. The CBDT circulars, being validly issued under Section 119, were binding on the authorities and provided a uniform test for recognizing doubtful claims. The Court emphasized that such circulars were consistent with Section 145 and ensured proper administration of the Income-tax Act. The appeals by Tamil Nadu Industrial Investment Corporation Ltd. were also allowed on similar grounds, applying the relevant CBDT circulars in force during the respective assessment years.