TaxTMI 
TaxTMI 
2010 (1) TMI 5
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....of the Appellant is July to June and the P&L Account and the Balance Sheet are drawn as on 30th June.The P&L Account and Balance Sheet is for shareholders, Reserve Bank of India (RBI) and Registrar of Companies (ROC) under the Companies Act, 1956. However, for IT Act, a separate P&L Account is made out for the year ending 31st March and the Balance Sheet as on that date is prepared and submitted to the Assessing Officer (AO) for computing the Total Income under the IT Act, which is not for use of RBI or ROC. 6. For the accounting year ending 31.03.1998, Assessee debited Rs. 81,68,516/- as Provision against NPA in the P&L Account on three counts, viz., Hire-Purchase of Rs. 57,38,980/-, Bill Discounting of Rs. 12,79,500/- and Loans and Advances of Rs. 31,84,701/-, in all, totalling Rs. 1,02,03,121/- from which AO allowed deduction of Rs. 20,34,605/- on account of Hire Purchase Finance Charges leaving a balance provision for NPA of Rs. 81,68,516/-. 7. Before the AO, Assessee claimed deduction in respect of Rs. 81,68,516/- under Section 36(1)(vii) being Provision for NPA in terms of RBI Directions 1998 on the ground that Assessee had to debit the said amount to P&L Account [in terms ....
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.... NPA" which is debited to P&L Account in terms of the RBI Directions 1998 and shown accordingly in the Balance Sheet can never be treated as income under Section 2(24) of the IT Act and added back while computing profits and gains of business under Sections 28 to 43D of the IT Act. 10. In reply, the Department contended before us that the IT Act is a separate code by itself; that the taxable total income has to be computed strictly in terms of the provisions of the IT Act; that the Reserve Bank of India Act, 1934 ("RBI Act" for short) operates in the field of monetary and credit system and that the said RBI Act never intended to compute taxable income of NBFC for income tax purposes; and, hence, there was no inconsistency between the two Acts. 11. According to the Department, RBI has classified all assets on which there is either a default in payment of interest or in repayment of the principal sum for more than the specified period as NPA. According to the Department, NPA does not mean that the asset has gone bad. It still continues to be an asset in the books of the lender, i.e., NBFC under the head "Debtors/Loans and Advances". According to the Department, RBI as a regulator w....
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....ting concept by insisting that the provision for NPA shall not be netted against the assets and should be shown separately on the liability side of the balance sheet so as to inform its user about the quantum and quality of NPA, in a more transparent manner. To this extent, there is a deviation from Part I of Schedule VI to the Companies Act, 1956. 12. Coming to the scope of Section 145 of the IT Act, it was submitted by the Department that Section 145 occurs in Chapter IV of the IT Act which deals with computation of total income. It indicates how the taxable income should be arrived at vide Sections 14 to 59. It is not an assessment Section. Section 145 helps to arrive at taxable total income. It nowhere indicates that the net profit arrived at shall be by adopting the accounting standards of Institute of Chartered Accountants of India (ICAI). It is the 1998 Directions which inter alia states that NBFC shall not recognize any income from an asset classified as NPA on mercantile system of accounting and that such Income shall be recognized only on cash basis. In the case under appeal, the Assessing Officer, in his wisdom, has not considered Rs.20,34,605/- as "income" (being incom....
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.... debit in the P&L Account or a statutory charge in the said Account as "real income". It is contended that under Section 145 of the IT Act, NBFCs are bound to follow the method of accounting prescribed by RBI. Hence, a statutory debit or a statutory charge under RBI Directions 1998 issued under Section 45JA of the RBI Act cannot form part of the "real income" and, consequently, it cannot be subjected to tax under the IT Act.According to the appellant(s), the "real income theory" is concerned with determining whether a particular amount can be treated as taxable income based on commercial principles. According to the appellant(s), the statutory provision for NPA represents an amount forming part of the value of the asset that the assessee is entitled to, but not likely to receive. According to the appellant(s), they are in the business of lending of money, financing by way of hire purchase, leasing or bill discounting. According to the appellant(s), on default, interest as well as the principal remains unrealized and, thus, the "provision for NPA" provides for a diminution in the amounts realizable (assets) and, consequently, "provision for NPA" cannot be treated as "real income" an....
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....ceipts in the P & L A/c irrespective of whether loss. there is profit or loss Provisions are a pretax charge tax to P & L account irrespective of whether the NBFC makes being a net profit or not. No reserve can be created in accounting year when there is a. Reserves are created out of post- profits, by way of appropriation, subject to there adequate net profit. 3. If NPA is Rs.10 lakhs, then the accounting entry is: P&L A/c Dr. 10,00,000 To Prov. for NPA 10,00,000 If there is a loss, the debit of Rs. 10,00,000/- will increase the quantum of loss. This aggregate loss will be shown on the assets side as debit balance of P&L A/c. If NPA is Rs.10 lakhs, and there is a loss, no "Reserve can be created. 4. Provision is based on a one- stage entry: P&L A/c Dr To Prov. For Excise/PF/Gratuity/etc Reserves are based on a two stage accounting process under the horizontal system. If the profits are Rs.10 crores, the Board of Directors may transfer Rs. 8 crores to P&L Appropriation A/c for taxation, dividend and reserve. The balance will be transferred to credit balance of P&L A/c. The entries will be as follows:- Stage 1: P&L A/c Dr.10.00 To P&L A....
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....quently, add back to the taxable income is not contemplated by the IT Act, nor is it contemplated under the "real income theory", however, if at all it has to be taken into account, it should be made allowable as a loss under Section 37(1) of the IT Act. Relevant Provisions (a) Of RBI Act, 1934 Chapter IIIB - PROVISIONS RELATING TO NON-BANKING INSTITUTIONS RECEIVING DEPOSITS AND FINANCIAL INSTITUTIONS Section 45I - Definitions In this Chapter, unless the context otherwise requires,- (a) "business of a non-banking financial institution" means carrying on the business of a financial institution referred to in clause (c) and includes business of a non-banking financial company referred to in clause (f); (aa) "company" means a company as defined in section 3 of the Companies Act, 1956 (1 of 1956), and includes a foreign company within the meaning of section 591 of that Act; (c) "financial institution" means any non-banking institution which carries on as its business or part of its business any of the following activities, namely:- (i) the financing, whether by way of making loans or advances or othervise, of any activity other than its own; (ii) the acquisition of shares, st....
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....up; (iii) all other non-banking financial companies; and (2) the book value of debentures, bonds, outstanding loans and advances (including hire-purchase and lease finance) made to, and deposits with,- (i) subsidiaries of such company; and (ii) companies in the same group, to the extent such book value exceeds ten per cent, of (a) above. 45-IC. Reserve fund (1) Every non-banking financial company shall create a reserve fund the transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared. (2) No appropriation of any sum from the reserve fund shall be made by the non-banking financial company except for the purpose as may be specified by the Bank from time to time and every such appropriation shall be reported to the Bank within twenty-one days from the date of such withdrawal: Provided that the Bank may, in any particular case and for sufficient cause being shown, extend the period of twenty-one days by such further period as it thinks fit or condone any delay in making such report. (3) Notwithstanding anything contained in sub-section (1), the Central Government may, on th....
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....r of Bank to collect information from non-banking institutions as to deposits and to give directions (1) The Bank may at any time direct that every non-banking institution shall furnish to the Bank, in such form, at such intervals and within such time, such statements information or particulars relating to or connected with deposits received by the non-banking institution, as may be specified by the Bank by general or special order. (2) Without prejudice to the generality of the power vested in the Bank under sub-section (1), the statements, information or particulars to be furnished under sub-section (1), may relate to all or any of the following matters, namely, the amount of the deposits, the purposes and periods for which, and the rates of interest and other terms and conditions on which, they are received. (3) The Bank may, if it considers necessary in the public interest so to do, give directions to non-banking institutions either generally or to any non-banking institution or group of non-banking institutions in particular, in respect of any matters relating to or connected with the receipt of deposits, including the rates of interest payable on such deposits, and the per....
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....ich interest amount remained overdue for a period of six months or more; (d) a bill which remains overdue for a period of six months or more; (e) the interest in respect of a debt or the income on receivables under the head `other current assets' in the nature of short term loans/advances, which facility remained overdue for a period of six months or more; (f) any dues on account of sale of assets or services rendered or reimbursement of expenses incurred, which remained overdue for a period of six months or more; (g) the lease rental and hire purchase instalment, which has become overdue for a period of twelve months or more; (h) in respect of loans, advances and other credit facilities (including bills purchased and discounted), the balance outstanding under the credit facilities (including accrued interest) made available to the same borrower/beneficiary when any of the above credit facilities becomes non-performing asset: Provided that in the case of lease and hire purchase transactions, an NBFC may classify each such account on the basis of its record of recovery; "non-performing asset" (referred to in these directions as "NPA") means :- (a) an asset, in respect of whi....
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....ted or rescheduled terms; Income recognition 3. (1) The income recognition shall be based on recognised accounting principles. (2) Income including interest/discount or any other charges on NPA shall be recognised only when it is actually realised. Any such income recognised before the asset became non-performing and remaining unrealized shall be reversed. (Effective from May 12, 1998) (3) In respect of hire purchase assets, where instalments are overdue for more than 12 months, income shall be recognised only when hire charges are actually received. Any such income taken to the credit of profit and loss account before the asset became non-performing and remaining unrealised, shall be reversed. (4) In respect of lease assets, where lease rentals are overdue for more than 12 months, the income shall be recognised only when lease rentals are actually received. The net lease rentals taken to the credit of profit and loss account before the asset became non-performing and remaining unrealised shall be reversed. Explanation For the purpose of this paragraph, `net lease rentals' mean gross lease rentals as adjusted by the lease adjustment account debited/credited to the profit and ....
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....be provided for. Explanation For the purpose of this paragraph, (1) the depreciated value of the asset shall be notionally computed as the original cost of the asset to be reduced by depreciation at the rate of twenty per cent per annum on a straight line method; and (2) in the case of second hand asset, the original cost shall be the actual cost incurred for acquisition of such second hand asset..." Additional provision for hire purchase and leased assets (ii) In respect of hire purchase and leased assets, additional provision shall be made as under : (a) Where any amounts of hire charges or lease rentals are overdue upto 12 months Nil Sub-standard assets: (b) where any amounts of hire charges or lease rentals are overdue for more than 12 months but upto 24 months 10 percent of the net book value Doubtful assets: (c) where any amounts of hire charges or lease rentals are overdue for more than 24 months but upto 36 months 40 percent of the net book value (d) where any amounts of hire charges or lease rentals are overdue for more than 36 months but upto 48 months 70 percent of the net book value Loss assets: (e) where any amounts of hire charges or lease rent....
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....(2) The provisions shall be distinctly indicated under separate heads of accounts as under :- (i) provisions for bad and doubtful debts; and (ii) provisions for depreciation in investments. (3) Such provisions shall not be appropriated from the general provisions and loss reserves held, if any, by the NBFC. (4) Such provisions for each year shall be debited to the profit and loss account. The excess of provisions, if any, held under the heads general provisions and loss reserves may be written back without making adjustment against them. Schedule to the balance sheet 9BB. Every NBFC shall append to its balance sheet prescribed under the Companies Act, 1956, the particulars in the format as set out in the schedule annexed hereto. (c) Of Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated July 1, 2009 2. DEFINITIONS 2.1 Non performing Assets 2.1.1 An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank. 2.1.2 A non performing asset (NPA) is a loan or an advance where; i. interest and/ or instalment of principal remain overdue for a period of more than 90 days in respec....
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....as all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, - on the basis of currently known facts, conditions and values - highly questionable and improbable. 4.1.3 Loss Assets A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. 5 PROVISIONING NORMS 5.1 General 5.1.1 The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements and the statutory auditors. The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines. (d) Of Income Tax Act, 1961 Section 36 - Other deductions [as it....
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....poration or the public company to its profit and loss account for that year or, as the case may be, in which it is actually received by that institution or bank or corporation or company, whichever is earlier. Reasons for RBI Directions 1998 18. On 31.01.1998, RBI Directions 1998 introduced a new regulatory framework involving prescription of Disclosure norms for NBFCs which are deposit taking to ensure that these NBFCs function on sound and healthy lines. Regulatory and supervisory attention was focussed on the deposit taking NBFCs so as to enable the RBI to discharge its responsibilities to protect the interest of the depositors. These NBFCs are subjected to prudential regulations on various aspects such as income recognition; asset classification and provisioning, etc. 19. The basis of every business is that anticipated losses must be taken into account but expected income need not be taken note of. This is the basis of the RBI Directive of 1998 as it is closer to reality of cash liquidity that prevents NBFC from collapse. 20. The RBI Directions 1998 deal with Presentation of NPA provision in the Balance Sheet of an NBFC. Before 1998, the Balance Sheet and P&L Account of an ....
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....ounting concepts. 23. It is important to note that the net profit shown in the P&L Account is the basis for NBFC to accept deposits and declare dividends. Higher the profits higher is the NOF and higher is the increase in the public making deposits in NBFCs. Hence the object of the NBFC is disclosure and provisioning. 24. NBFCs have to accept the concept of "income" as evolved by RBI after deducting the Provision against NPA, however, as stated above, such treatment is confined to Presentation / Disclosure and has nothing to do with computation of taxable income under the IT Act. Scope of the Finance Act No. 2 of 2001 w.e.f.1.4.1989 insofar as Section 36(1)(vii) is concerned. 25. Prior to1.4.1989, the law, as it then stood, took the view that even in cases in which the assessee (s) makes only a provision in its accounts for bad debts and interest thereon and even though the amount is not actually written off by debiting the P&L Account of the assessee and crediting the amount to the account of the debtor, assessee was still entitled to deduction under Section 36(1)(vii). [See Commissioner of Income Tax v. Jwala Prasad Tewari 24 ITR 537 and Vithaldas H. Dhanjibhai Bardanwala (su....
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....rom the list as "provision for doubtful debts" .However, these are matters of Presentation of Provisions for doubtful debts even under the Companies Act and have nothing to do with taxability under the IT Act. One more aspect needs to be mentioned. Section 36(1) (vii) is subject to sub-section (2) of Section 36. The condition incorporated in Section 36 of the IT Act, which was not there in Section 10(2)(xi) of the 1922 Act, is that the amount of debt should have been taken into account in computing the income of the assessee in the previou year. Under the IT Act, the emphasis is not on the assessee being the creditor but taking into account of the debt in computing the business income. [See Section 36(2)] In Commissioner of Income-tax, A.P. v. T. Veerabhadra Rao K. Koteswara Rao & Co. reported in 155 ITR 152 at 157, it was found that the debt was taken into account in the income of the assessee for the assessment year 1963-64 when the interest accruing thereon was taxed in the hands of the assessee. The said interest was taxed as income as it represented accretion accruing during the earlier year on the moneys owed to the assessee by the debtor. It was held that transaction consti....
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....s income accrues with time. In such cases, interest is charged and debited to the account of the borrower as "income" is recognized under accrual system. However, it is not so recognized under the 1998 Directions and, therefore, in the matter of its Presentation under the said Directions, there would be an add back but not under the IT Act necessarily. It is important to note that collectibility is different from accrual. Hence, in each case, the assessee has to prove, as has happened in this case with regard to the sum of Rs.20,34,605/-, that interest is not recognized or taken into account due to uncertainty in collection of the income. It is for the assessing officer to accept the claim of the assessee under the IT Act or not to accept it in which case there will be add back even under real income theory as explained hereinbelow. Scope and applicability of RBI Directions 1998 32. RBI Directions 1998 have been issued under Section 45JA of RBI Act. Under that Section, power is given to RBI to enact a regulatory framework involving prescription of prudential norms for NBFCs which are deposit taking to ensure that NBFCs function on sound and healthy lines. The primary object of th....
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....ture under the IT Act cannot be conclusively determined by the manner in which accounts are presented in terms of 1998 Directions. There are cases where on facts courts have taken the view that the so-called provision is in effect a write off. Therefore, in our view, RBI Directions 1998, though deviate from accounting practice as provided in the Companies Act, do not override the provisions of the IT Act. Some companies, for example, treat write offs or expenses or liabilities as contingent liabilities. For example, there are companies which do not recognize mark-to-market loss on its derivative contracts either by creating reserve as suggested by ICAI or by charging the same to the P&L Account in terms of Accounting Standards. Consequently, their profits and reserves and surplus of the year are projected on the higher side. Consequently, such losses are not accounted in the books, at the highest, they are merely disclosed as contingent liability in the Notes to Accounts. The point which we would like to make is whether such losses are contingent or actual cannot be decided only on the basis of presentation. Such presentation will not bind the authority under the IT Act. Ultimately....
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.... between the real profits and statutory profits. The latter are statutorily fixed for a specified purpose". 37. To the same effect is the judgment of the Bombay High Court in the case of Commissioner of Wealth-Tax, Bombay v. Bombay Suburban Electric Supply Ltd. 103 ITR 384 at page 391, where it was observed as under: "Income Tax is a tax on the real income, i.e., profits arrived at on commercial principles subject to the provisions of the Income Tax Act, 1961. The real profits can be ascertained only by making the permissible deductions". 38. The point to be noted is that the IT Act is a tax on "real income", i.e., the profits arrived at on commercial principles subject to the provisions of the IT Act. Therefore, if by Explanation to Section 36(1)(vii) a provision for doubtful debt is kept out of the ambit of the bad debt which is written off then, one has to take into account the said Explanation in computation of total income under the IT Act failing which one cannot ascertain the real profits. This is where the concept of "add back" comes in. In our view, a provision for NPA debited to P&L Account under the 1998 Directions is only a notional expense and, therefore, there woul....
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....ctions and Companies Act is only in the matter of Income Recognition and presentation of Financial Statements. The Accounting Policies adopted by an NBFC cannot determine the taxable income. It is well settled that the Accounting Policies followed by a company can be changed unless the AO comes to the conclusion that such change would result in understatement of profits. However, here is the case where the AO has to follow the RBI Directions 1998 in view of Section 45Q of the RBI Act. Hence, as far as Income Recognition is concerned, Section 145 of the IT Act has no role to play in the present dispute. Analysis of Section 36(1) (viia) 41. Section 36(1) (vii) provides for a deduction in the computation of taxable profits for the debt established to be a bad debt. 42. Section 36(1)(viia) provides for a deduction in respect of any provision for bad and doubtful debt made by a Scheduled Bank or Non-Scheduled Bank in relation to advances made by its rural branches, of a sum not exceeding a specified percentage of the aggregate average advances by such branches. Having regard to the increasing social commitment, Section 36(1) (viia) has been amended to provide that in respect of provi....
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.... charged to tax only in the year of receipt or the year in which it is credited to the P&L Account, whichever is earlier. 49. Before concluding, we may state that none of the judgments cited on behalf of the appellant(s) are relevant as they do not touch upon the concept of NPA. In our view, the issues which arise for determination in this case did not arise in the cases cited by the appellant(s). Challenge to the constitutional validity of Sections 36(1) (viia) and 43D of the IT Act. 50. According to NBFCs, there is no reason why a Provision for NPA of an NBFC be treated differently from a provision for NPAs of banks, SFCs, HFCs, etc. According to NBFCs, the Disclosure Norms for NBFCs are designed to bring NBFCs in line with banks, SFCs, HFCs, etc. That, if NPAs are similar to Doubtful Debts, then permitting deductions only in the case of Provisions for doubtful debts of banks, cooperative financial corporations, etc. will violate Article 14 of the Constitution.In this connection, it was submitted that when banks, financial institutions and NBFCs are all subject to RBI norms in the matter of Income Recognition, denial of deduction only to NBFCs in respect of Provisions which th....
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....ntioned in Sections 36(1) (viia) and 43D are often restricted to banks and not to NBFCs. Lastly, as stated above, even in the case of banks the Provision for NPA has to be added back and only after such add back that deduction under Section 36(1) (viia) can be claimed by the banks. Therefore, even in the case of banks, there is an element of add back, however, by way of special provision banks are allowed to claim deduction under Section 6(1)(viia). One more aspect needs to be mentioned, apart from the fact that NBFCs and Banks are two different entities, under Section 36(1)(viia) the banks are allowed deductions subject to a ceiling or a limit and if the contentions of NBFCs are to be accepted that NBFCs should also be included in Section 36(1)(viia), then, we will be undertaking judicial legislation which is not allowed, hence, in our view, we hold that neither Section 36(1)(viia) nor Section 43D violates Article 14. We further hold that the test of "intelligible differentia" stands complied with and hence we reject the challenge. 53. As regards challenge to the validity of Sections 43D and 36(1) (viia) as violative of Article 19, we find that RBI Directions 1998 govern the busi....
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.... its own people, its laws are directed to problems made manifest by experience and its discrimination is based on adequate grounds. There may be cases where the legislation can be condemned as arbitrary or irrational, hence, violative of Article 14. But the test in every case would be whether the provisions of the Act are arbitrary and irrational having regard to all the facts and circumstances of the case. Immorality, by itself, cannot be a constitutional challenge as morality is essentially a subjective value. The terms "reasonable, just and fair" derive their significance from the existing social conditions. 56. In the case of Bhavesh D. Parish v. Union of India, (2000) 5 SCC 471, this Court laid down that while considering the scope of economic legislation as well as tax legislation, the courts must bear in mind that unless the provision is manifestly unjust or glaringly unconstitutional, the courts must show judicial restraint in interfering with its applicability. Merely because a statute comes up for examination and some arguable point is raised, the legislative will should not be put under a cloud. It is now well settled that there is always a presumption in favour of the ....