| SooperKanoon Citation | sooperkanoon.com/73303 |
| Court | Income Tax Appellate Tribunal ITAT Hyderabad |
| Decided On | Jul-30-2004 |
| Judge | D Manmohan, J S Reddy |
| Reported in | (2004)91ITD573(Hyd.) |
| Appellant | T.C.i. Finance Ltd. |
| Respondent | Asstt. Cit, Range 3 |
2. The assessee has raised nine grounds in this appeal which involve the following issues:- Inclusion in the total income of the sum of Rs. 1,23,59,180 being unrealized finance charges on hire purchase agreements (Rs. 24,00,077), unrealized lease rentals (Rs. 97,50,771) and unrealized interest (Rs. 2,08,332) on loans and advances to - M/s Share Medical Care, as alleged accrued income assessable to tax for the year under appeal under the mercantile system of accounting - Ground Nos. 1 to Inclusion in the total income of Rs. 2,47,123 being unpaid interest allegedly accrued and receivable from Godavari Capital Limited for then year under appeal under the mercantile system of accounting - Ground Nos. 6 and 7.
Disallowance of legal expenses of Rs. 21,84,009 incurred for conducting legal proceedings against the defaulting debtors - Ground Nos. 8 and 9.
3. The assessee is a company deriving income from business of finance and leasing. The facts relating to the first issue are as follows. The assessee made a note in the computation statement stating that in accordance with prudential norms prescribed by Reserve Bank of India for income recognition which are binding on the company, an amount of Rs. 1,23,59,180 was not included. In this connection, the Assessing Officer asked the assessee to explain in detail the reasons for non-recognition of income and non-inclusion of the same in the total income. The assessee furnished a detailed explanation stating that during the accounting year relevant for asst. year 1999-2000 the assessee company had not included the following unpaid finance charges as income in the accounts:-On hire purchase agreement 24,00,077On lease rental 97,50,771On loans and advances 2,08,332 The assessee further mentioned that the principal amounts due in respect of the aforesaid amounts had not similarly been paid for a long time and were extremely doubtful of recovery. The Assessing Officer set out the arguments of the assessee in this behalf at pages 3 and 4 of the assessment order. For the reasons mentioned in his order at pages 4 to 6, the AO rejected the claim of the assessee and included the total amount of Rs. 1,23,59,180 in the total income of the assessee.
According to the AO, the assessee was required to offer income on accrual basis since the method of accounting adopted is mercantile system of accounting; on non-receipt of any income, the assessee was competent to write off under' Section 36 of the Income-tax Act, 1961, as bad debts after actually writing off from the books of account; and the Prudential Norms issued by the RBI do not override the provisions of the Income-tax Act. He referred to Notification dated 25-1-1996 issued by the Central Government notifying the Accounting Standard [218 ITR (St.) 1]. He also Supreme Court in the cases referred to in his order, viz. Tuticorin Alkali Chemicals & Fertilisers Ltd. v. CIT (1997) 227 ITR 172, CIT v. Shiv Prakash Janak Raj & Co. Pvt. Ltd. (1996) 222 ITR 583, and CIT v. Chamanlal Mangaldas & Co. (1960) 39 ITR 8. In first appeal, the CIT (A) upheld the action of the AO. He also referred to the decision of the Income-tax Appellate Tribunal, Jaipur Bench, in the case of Bank of Rajasthan Ltd. v. ACIT, 68 ITD 69, wherein the Tribunal held that the procedure laid down by the RBI cannot be followed in computing the total income under the Income-tax Act. Aggrieved by the order of the CIT (A), the assessee is in appeal before the Tribunal.
4. The learned counsel for the assessee submitted that the assessee company has admittedly been consistently following mercantile system of accounting for a very long time, that the assessee is a non-banking financial company within the meaning of Section 45I(f) of the Reserve Bank of India Act, 1934, and that it is duly registered with the Reserve Bank of India under Section 45IA of the said Act. He filed a paper .book in which a copy of the Registration Certificate has been placed at page 119. He further stated that in pursuance of the recommendation made by the Working Group on Financial Companies headed by Dr. A.C. Shah (Shah Working Group), the RBI through its circular dated 12-4-1993, advised all Non-Banking Financial Companies (NBFCs) and Residuary Non-Banking Companies (RNBCs) that RBI would be introducing capital adequacy norms based on risk weights for differe types of assets and off - balance sheet items and it would also prescribe prudential norms for income recognition, transparency of accounts and provisioning for bad and doubtful debts etc. The RBI introduced these prudential norms initially through its Circular No.DFC.COC. No. 1707.174.93-94 dated 13-6-1994, a copy of which has been placed at pages 120-128 of the paper book. Para 2.1 of the said prudential norms (page 121 of PB) clearly laid down that income from non-performing assets (NPA) may not be recognized merely on the basis of accrual. An asset becomes non-performing when it ceases to yield income. The income from NPAs should be recognized only when it is actually received. It was further stated by the RBI in the said circular that interest on NPAs should not be booked as income if such interest has remained outstanding for more than six months on and from 31^st March 1995. Similarly, para 2.3 of the said circular further laid down that where lease rentals/hire purchase instalments were overdue for more than six months, the entire dues from the lessee/hirer should be treated as NPA. The learned counsel stated that the assessee company started obeying and following these prudential norms from the financial year ending 31-3-1995 corresponding to asst. year 1995-96.
5. The learned counsel further submitted that in the course of financial years corresponding to asst. years 1995-96, 1996-97, 1997-98 and 1998-99, the assessee company did not account for the so-called allegedly accrued interest and/or finance charges on lease and hire purchase agreements including loans and advances etc. following the aforesaid circular dated 13-6-1994 issued by RBI, although it continued to follow the mercantile system of accounting. He further stated that the Assessing Officer in each of those years asked the assessee company to explain as to why the unprovided interest and finance charges should not be taxed as income following the mercantile system of accounting consistently followed by it. There was correspondence between the assessee company and the AO in those four years. Copies of the correspondence appear at pages 129 to 142 of the paper book. In short, it was explained on behalf of the assessee company that mercantile system of accounting-does not envisage taking into account hypothetical income. When there was continuous non-recovery from the lessees, hirer and/or loan debtors, and when the assessee company was of the view that even the principal amount itself was doubtful of recovery, no income could be said to have accrued even under the mercantile system of accounting. The accrual of income has to be judged from a realistic point of view. It was further submitted that when a statutory body like the RBI prescribes norms and guidelines under the law as to "Income Recognition" as well as "Accounting Standards" and prescribes prudential norms as to when the income should be taken to have accrued, the assessee company, being a non-banking financial company, had no option but to accept these guidelines and act in terms of the prudential norms laid down by the RBI. The Assessing Officers accepted the submissions made on behalf of the assessee in each of the aforesaid four years and completed the assessments in its case for the said four years without bringing to tax the so-called allegedly accrued income by way of interest and/or finance charges on hypothetical basis, even though the method of accounting adopted by the assessee company continued to be mercantile, as before.
6. The learned counsel for the assessee drew our attention towards the details of unpaid hire purchase finance charges and unpaid lease finance charges at pages 21-24 and page 25 of the paper book filed by him. He submitted that it is apparent that in a large number of cases no payments had been received by the assessee company for a very long time. AH these cases were NPA as per the Directions of the RBI (pages 104-118 of PB) under Notification No. DFC. 119/DG (SPT) - 98 issued under Section 45JA of the Reserve Bank of India Act, 1934, viz. "Non Banking Financial Companies Prudential Norms (Reserve Bank) Direction 1998" dated 31-1-1998. The assessee company, therefore, did not provide in its books of accounts for the "unpaid hire finance charges" in the aggregate sum of Rs. 24,00,077 and "unpaid lease finance charges" in the aggregate sum of Rs. 97,57,771, in its books of accounts drawn for the financial year ending 31-3-1999 corresponding to asst. year 1999-2000, since these were past due and outstanding for more than 12 months as on 31-3-1999. Similarly, Rs. 2,08,332 represented the unpaid interest (Rs. 2,88,192 minus tax deductible at source Rs. 79,860) for the period April 1998 to September 1998, due and receivable from M/s Share Medical Care, which party did not make any payment from 1-4-1998 onwards till 31-3-2000, as is evident from pages 70, 71 and 74A of the paper book of the assessee. This interest was outstanding and was past due for more than six months as on 31-3-1999, the last day of the previous year relevant to asst. year 1999-2000. Thus, the aggregate sum of Rs. 1,23,59,180 represented unpaid finance charges and interest falling in the NPA category. In a large number of such cases no realizations were made even after taking legal action. The Board of Directors of the assessee company at the Board meeting held on 28-1-1999 considered the matter in depth and formed the belief that - there was continuous failure on the part of the concerned debtors in payment of dues as per the agreement; In the printed notes on audited accounts (para 11 at page 102 of PB), it was inter alia recorded that being a non-financial company, the assessee was required to follow the prudential norms prescribed by RBI for income recognition and provision for non-performing assets and in compliance with the said norms, the assessee company did not recognize the finance income in the aggregate sum of Rs. 1,23,59,180 and it also reversed the finance income recognized in earlier years, in the aggregate sum of Rs. 47,90,510 (Rs. 35,96,822 for hire purchase and Rs. 11,93,698 on account of lease rentals).
7. The learned counsel further submitted that in the course of assessment proceedings for asst. year 1999-2000, the assessee company by its letter dated 7-3-2002 (page 30 of PB) and the detailed note (pp.
32 and 33 of PB), reiterated the aforesaid position in reply to the AO's letter dated 3-1-2002 (page 26 of PB). The aforesaid facts had also been disclosed by the assessee in its computation of total income filed along with its return for the said year, copy whereof appears at pages 80 and 81 of the paper book. The learned AO accepted the stand of the assessee in regard to the reversed finance income, recognized in the earlier years, in the aggregate sum of Rs. 47,90,510, which was claimed as bad debts under Section 36(1)(vii) read with Section 36(ii) of the Income-tax Act, 1961, and para 3(3) of the NBFC Prudential Norms, RBI Directions, 1998, issued by the RBI on 31-1-1998. However, the learned AO had arbitrarily added the said sum of Rs. 1,23,59,180 in the total income of the assessee company for the year under appeal, on account of allegedly accrued interest and finance charges which was upheld by the CIT (A).
8. The arguments of the learned counsel for the assessee are summarized as under:- Both the AO and the CIT (A) did not appreciate the basic fact that there was no accrual of income in the facts and circumstances of the instant case. It is by now well settled by several judicial pronouncements that there can be no accrual of interest or finance charges on hire purchase/leases/loans & advances, even under the mercantile system of accounting, when the principal amount itself is doubtful of recovery. Regular mode of accounting only determines the mode of computing taxable income and the point of time at which the tax liability is attracted. It cannot determine or affect the range of taxable income or the ambit of taxation. Where no income has resulted, it cannot be said that income has accrued merely on the ground that the assessee has been following mercantile system of accounting. If no income has materialized, there can be no liability to tax a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account, but what should be considered is, whether the income has really materialized or resulted to the assessee'. The question whether real income has materialized to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee is placed and not with reference to his system of accounting. Reliance was placed on the following decisions:- CIT v. Motor Credit Co. Pvt. Ltd. (1981) 127 ITR 572 (Mad) at 576 [SLP by department dismissed by Supreme Court reported in (1984) 149 ITR (St.) 93] .
Sri Kewal Chand Bagri v. CIT (1990) 183 ITR 207, 209-212 (Cal) reiterated in CIT v. Method Training & Investment Ltd. (2000) 246 ITR 588, 599-601 (Cal) The provisions contained in the Non Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998, are binding on the assessee company in view of the clear provisions contained in Section 45JA(1) of the Reserve Bank of India Act, 1934. The aforesaid directions contained clear pronouncement by the Reserve Bank of India in relation to income recognition, accounting standards, making of proper provisions for bad and doubtful debts etc. These directions have been issued by RBI in exercise of the powers conferred on it by Section 45JA of the Reserve Bank of India Act, 1934, as clearly set out in its Preamble (page 104 of the PB).
Section 45JA was introduced in Chapter IIIB of the Reserve Bank of India Act, 1934, by the Amendment Act of 1997. Section 45Q of the said Act clearly provides that provisions contained in Chapter IIIB of the RBI Act shall have effect "notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law." As such, the provisions of Section 45JA contained in Chapter IIIB of the RBI Act override the Income-tax Act, 1961, as well as the agreements entered into between the assessee company and its hirer/lessees/loanees.In Peerless General Finance & Investment Co. Ltd. and Anr. v. Reserve Bank of India (1992) 2 SCC 343, the apex court, dealing with similar provisions contained in Sections 45K3) & (4) and 45L(1)(b) and forming part of Chapter III B of the Reserve Bank of India Act, 1934, clearly laid down that the directions issued under Chapter III B of the said Act were statutory regulations. Non-banking institutions are bound to comply with such directions and non-compliance thereof attracts penal action. This principle was reiterated by Hon'ble Supreme Court in RBI v. Peerless General Finance & Investment Co. Ltd. (1996) 1 SCC 642. In view of the aforesaid decisions of the Supreme Court, the AO and the CIT (A) were not right in alleging and/or observing that the assessee company had changed its accounting policy according to its convenience, and had not observed certain standards. The assessee had not changed its accounting policy or system in not providing for the unrealized interest and finance charges totaling Rs. 1,23,59,180. No interest or finance charges can accrue even under the mercantile system when the recovery of the principal itself is doubtful, which is the admitted and undisputed case here. Mercantile system does not talk about hypothetical accrual.
Even assuming for the sake of argument, but not admitting, that there was a change in the method of accounting employed by the assessee, the so-called change did not take place in the previous year relevant to the asst. year under appeal. The change, if at all, took place in the financial year 1994-95, when the RBI had issued the earlier prudential norms dated 13-6-1994, which were followed in that year and thereafter consistently. The tax authorities had all along accepted the so-called changed method for the purpose of making income-tax assessments in the case of the assessee company right from asst. year 1995-96 and onwards. The so-called change in method of accounting is in compliance with the directions issued by the Reserve Bank of India which are statutory in nature and binding on all NBFCs including the assessee company.
The recent decision of the Delhi Bench of the Income-tax Appellate Tribunal in Tedco Investment Services Pvt. Ltd. v. DCIT (2003) 87 ITD 298, which dealt with identical matter, also fully supports the case of the assessee. In that case, the Tribunal has held that the addition made by the Assessing Officer disregarding the prudential norms issued by the RBI under Chapter IIIB of the Reserve Bank of India Act, 1934, was wholly unjustified in law.
9. In support of his contentions, the learned counsel for the assessee also placed reliance on the decision of Hon'ble Supreme Court in the case of Godhra Electricity Co. Ltd. v. CIT (1997) 225 ITR 746, in particular the observations at pages 757, 758 and 760 of the report, wherein the apex court observed that it is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income and that the question whether there was real accrual of income to the assessee-company has to be considered by taking the probability or improbability of realization in a realistic manner. He also cited the decision of Hon'ble Calcutta High Court in CIT v. Method Trading & Investment Ltd. (2000) 246 ITR 588, at 599-600.
Further, the learned counsel distinguished the case laws cited by the AO in the assessment order. He also distinguished the decision of the ITAT, Jaipur Bench, 68 ITD 69, referred to by the CIT (A), on facts. He submitted that the decision of Hon'ble Calcutta High Court in UCO Bank's case, reported in 200 ITR 68, relied upon by the Tribunal in that case has already been overruled by Hon'ble Supreme Court as reported in 240 ITR 355. Furthermore, no directions issued by the RBI under Chapter IIIB of the RBI Act, 1934, were claimed by the assessee in that case to be applicable and/or sought to be applied there. That apart, the provisions of Chapter IIIB, more particularly Sections 45JA, 45K and/or 45L and/or 45Q were not brought to the notice of and/or considered by the Tribunal in that case. The decision of the Supreme Court in Peerless's case as to the binding nature of these directives and the provisions of Chapter IIIB and the directions issued thereunder being statutory in nature, had not .been brought to the notice of the Tribunal. In that case, the Tribunal considered a question as to whether losses on account of revaluation of securities held by the bank should be allowed in computing the total income under the Income-tax Act. In paragraph 7 at page 77 of the report, the Tribunal noted that the shares and securities held by the assessee bank were all along held as investments and not as stock-in-trade and that such securities in the books of account had been valued at cost and the revaluation was done only for income-tax purposes. The Tribunal, referring to the decision of Calcutta High Court in CIT v. Uco Bank (supra), held that the loss on revaluation carried out only for income-tax purposes and not in the regular books of account, could not be accepted for computing the total income under the tax laws, having regard to the fact that in the books of account the securities were shown as investments. The decision of the Hon'ble Supreme Court in Investment Ltd. v. CIT (1970) 77 ITR 533, 538, wherein the apex court had already held that showing the shares and securities in the balance sheet as investments was not decisive of the issue whether such shares and securities were part of stock-in-trade or were just investments, had not been brought to the notice of the Tribunal in that case. Overruling the decision in the case of UCO Bank (supra), the apex court clearly held that it was perfectly justified for a banking company to value the securities (investments) at cost in its balance sheet prepared in accordance with Banking Regulations Act and revalue the very same investments at cost or market value, whichever is lower, for income-tax purposes and the loss on revaluation cannot be disallowed, because this method was consistently followed and accepted by the Revenue in the earlier years. The issue of revaluation of securities is not at all dealt with in any directives issued by the RBI under the RBI Act, 1934.
In fact, Section 45H under Chapter IIIB of the RBI Act makes it quite clear that provisions of that chapter would not apply to any banking company as defined in Section 5 of the Banking Regulation Act, 1949. In this view of the matter, the learned counsel submitted that the observation made by the Tribunal in paragraph 6 of its aforesaid order in the case of Bank of Rajasthan is wholly obiter and is not based on any provision of the RBI Act, 1934. He further submitted that the said decision of the Tribunal does not lay down the correct law in view of the earlier and later judgments of Hon'ble Supreme Court.
10. Another addition similarly made by the AO is Rs. 2,47,123 on account of unpaid interest accrued and receivable from Godavari Capital Ltd. The learned counsel for the assessee submitted that as against an amount of Rs. 4,47,123 due from Godavari Capital Ltd., the assessee had received only a sum of Rs. 2,00,000 on 14/15-7-1998 by cheque. A copy of the covering letter of the party dated 14-7-1998 has been placed at page 66 of the assessee's paper book. The payment was made in full and final settlement of all its dues. The assessee wrote off the balance sum of Rs. 2,47,123. However, instead of debiting Rs. 2,47,123 directly to profit and loss account, the assessee deducted the said amount from the gross interest received/receivable. The net effect, however, was the same. The learned counsel submitted that in view of the settlement, the balance interest of Rs. 2,47,123 was no longer realizable and cannot lawfully be assessed on deemed accrual basis.
11. In view of the aforesaid submissions, the learned counsel contended that the additions on account of unrealized finance charges, unrealized lease rentals and unrealized interest, sustained by the first appellate authority, should be deleted.
12. On the other hand, the learned departmental representative supported the decision of the revenue authorities on the issues before us. He submitted that the submissions of the learned counsel for the assessee in support of the contention that the income in question could not be said to have accrued even under the mercantile system of account on account of real income concept, are not correct. He submitted that Income-tax Act levies charge of income-tax on the Total Income as per Section 4 and further Section 5 of the Act defines the scope of Total Income, as per which all income which accrues or arises to the assessee in a previous year in India has to be taxed in the relevant assessment year. He stated that the aspect of accrual of income was elaborated by Hon'ble Supreme Court in the case of CIT v. KRMTT Chetty & Co., 24 ITR 525, which decision was followed by the apex court in other decisions including the landmark decision in the case of Morvi Industries Limited v. CIT, 82 ITR 835. He referred to page 840 of the report where the meaning and scope of the word 'accrual' has been explained as under:- "The dictionary meaning of the word "accrue" is "to come as an accession, increment or produce: to fall to one by way of advantage: to fall due". The income can thus be said to accrue when it becomes due. The postponement of the date of payment has a bearing only in so far as the time of payment is concerned, but it does not affect the accrual of income. The moment the income accrues, the assessee gets vested with the right to claim that amount even though it may not be immediately. There also arises a corresponding liability of the other party from whom the income becomes due, to pay that amount. The further fact that the amount of income is not subsequently received by the assessee would also not detract from or efface the accrual of the income, although the non-receipt may, in appropriate cases, be a valid ground for claiming deductions. The accrual of an income is not to be equated with the receipt of the income." As per the above principle, the income accrues as soon as the right to claim the amount gets vested with the assessee irrespective of whether it is subsequently received or not. These aspects have been further elaborated in the recent decision of Hon'ble Delhi High Court in Saraswathi Insurance Co. v. CIT, 252 ITR 430. In this connection, the learned DR also referred to the order of the ITAT, Hyderabad Bench, dated 10-5-2003 in I.T.A. No. 699/Hyd/2002 in the case of Shakunthala Rathi, as also the recent judgment of Hon'ble Rajasthan High Court in the case of S.M.S. Investment Corporation (P) Ltd. v. CIT.13. The learned DR. further submitted that it is not disputed that the assessee is maintaining accounts on mercantile basis and therefore income should have been computed on the basis of accrual, in view of clear provisions of Section 5 and Section 145 of the Income-tax Act, 1961. As far as accounting standards prescribed by Government vide Notification No. SO 69(E) dated 25-1-1996, are concerned, the learned DR submitted, it is clearly stated in paragraph 5 of Part A that fundamental accounting assumptions are relating to accrual. Accrual has been further explained in para 6(b). As for the reference of the learned counsel for the assessee to paragraph 9 which falls in ASII relating to disclosure of prior period and extraordinary items and changes in accounting policies, the learned DR submitted that in the present case we are not concerned with prior period or extraordinary items and para 13(c)-proviso clearly states that income or expenses arising from the ordinary activities shall not qualify as extraordinary items. Thus the norms set out by the RBI regarding recognition of income will not override the provisions of computation of income as prescribed by Section 145 read with Notification No. 69(E) in respect of commutation of income of an assessee. In this connection, he referred to the decision of Hon'ble Supreme Court in the case of British Paints, 188 ITR 44.
14. The learned DR further submitted that the fields of operation of Income-tax Act, RBI Act and other Acts of legislature are different. In this connection, he invited reference to the decision of Special of the ITAT, Hyderabad, in the case of Nagarjuna Investment Trust Ltd., 65 ITD 17, wherein the principles of taxation have been explained in detail in paragraph 26(c) at page 58 of the report. He submitted that the Special Bench has held that the principles of taxation as per sec, 5 of the Income-tax Act will be effective as far as taxation under income-tax is concerned, even if the assessee has maintained accounts as per the Companies Act or any other Act. According to the learned DR, there is no objection to making entries in the books of account of the assessee as per RBI norms but in view of the provisions of Section 5 of the Income-tax Act read with Section 145, the assessee has to pay tax on income in respect of which the assessee has a right to receive and which has accrued to the assessee in the relevant previous year as per contracts. As far as the case of UCO Bank [237 ITR 889 (SC)] is concerned, Hon'ble Supreme Court has held that in view of the beneficial circular issued by CBDT, the amounts credited to suspense account by the bank may not be brought to tax. The decision was based on the principle that CBDT has power to issue a circular beneficial to the assessee relaxing the rigours of law. It would be relevant to mention here, the learned DR submitted, that such power to issue beneficial circulars in the field of taxation has not been given to the RBI.15. Coming to the concept of Real Income, the learned DR submitted that this concept is considered in detail by Hon'ble Supreme Court in the case of State Bank of Travancore, 158 ITR 102, followed in the case of Shivprakash Janak Raj, 222 ITR 583, and subsequent cases. He stated that it would be relevant to mention that the assessee never claimed that non-recognition of accrued income was based on any concept of real income enunciated by Hon'ble courts. If the assessee were to claim benefit of this theory, it has to show case by case as to what were the factors effacing the accrual of income in the relevant previous years.
Since the assessee has not discharged the onus in any manner, there was no validity of taking this ground at the stage of appeal before the ITAT, without any evidence having been furnished case-wise before the lower authorities. The learned DR further submitted that the decisions of Hon'ble Supreme Court reported in 158 ITR 102, 225 ITR 703 and 225 ITR 746, relied upon by the learned- counsel for the assessee, actually support the department's stand rather than the assessee's case since it has been held in the aforesaid decisions that the concept of real income has to be applied in the reality of the situation and mere improbability of recovery cannot result into non-accrual of income. It has also been held that the concept should not be so read as to defeat the provisions of the Income-tax Act. The assessee's claim was always based on the mechanical norms of RBI rather than any considerations of real income concept, and hence the benefit of this theory should not be allowed to the assessee.
16. The learned DR submitted that the question whether the provisions of Section 45Q of the RBI Act and the provisions of Chapter III-B of the said Act have overriding effect on the provisions of other Acts including the Income-tax Act is also to be considered in the right perspective. It is an established principle of law that the provisions of any legislation operate in the respective field and not in the fields of other Acts. What Section 45Q states is that the provisions of Chapter III-B shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force.
According to the learned DR, the objective of the entire RBI Act is given in the preamble of the Act which reads as under: - Whereas it is expedient to constitute a Reserve Bank of India to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in (India) and generally to operate the currency and credit system of the country to its advantage: And whereas in the present disorganization of monetary system of the world it is not possible to determine what will be suitable as a permanent basis for the Indian monetary system: But whereas it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary stands best suited to India to be considered when the intentional monetary position has become sufficiently clear and stable to make it possible to frame permanent measures:" The objects of the RBI Act as set out in the aforesaid preamble aim at regulating the currency and credit system and monetary policy of the country and not to regulate the taxation of income in any manner. The principles and scope of the RBI guidelines have been explained by Hon'ble Supreme Court in the case of Peerless reported in 2 SCC 343, which is to safeguard the interest of the depositors and regulate the operations of the non-banking companies. Hence, the provisions of Section 45Q have to be understood with reference to the aims and objects of the RBI Act and the context in which the guidelines were issued thereunder. These objects do not in any way infringe on the area of taxation which is covered by the Income-tax Act, 1961, which is also an Act of Parliament operating in its particular field. Thus, there is no inconsistency or anomaly between the Income-tax Act and the RBI Act, because these Acts operate in different fields. For the proposition that Income-tax Act and RBI Act have different fields of operation, the learned DR placed reliance on the following case laws:- 17. The learned DR lastly submitted that the ground taken by the learned counsel for the assessee that RBI guidelines have to be followed in the matter of taxation also notwithstanding the accrual of income under the income-tax law, is devoid of any legal merit and such contention would make the charging Section of the Income-tax Act, Section 5, nugatory. In this connection, he placed reliance upon the decision of Hon'ble Supreme Court in the case of S. Mohan Lal v. R.Kondiah, AIR 1979 SC 1132, wherein the following observations have been made: "It is not a sound principle of construction to interpret expressions used in one Act with reference to their use in another Act; more so if the two Acts in which the same word is used are not cognate Acts. Neither the meaning nor the definition of the term in one statute affords a guide to the construction of the same term in another statute and the sense in which the term has been understood in the several statutes does not necessarily throw any light on the manner in which the term should be understood generally. On the other hand, it is a sound, and indeed a well known, principle of construction that meaning of words and expressions used in an Act must take their colour from the context in which they appear." According to the learned DR, on the above principle it can be said that the concept of income recognition under RBI norms cannot be imported into the field of taxation which is governed by Income-tax Act. All the aforesaid case laws clearly show that the principles contained in the RBI Act and guidelines cannot be imported into the income-tax law which has a different field of operation and effect. The RBI norms are for safeguarding the interest of depositors and regulating the functioning of NBFCs which has nothing to do with the principle of taxation. Hence, the assessee's conduct in not showing income which had accrued as per the relevant contracts and in respect of which the assessee had a valid and real legal right to receive, is improper and has no sanction under the Income-tax Act. The basic stand of the assessee appears to be that even if the debtors/parties are sound and there is no legal impediment or improbability in realizing the income, the same will not be considered as accrued if the receipt is delayed, according to the norms prescribed by the RBI. Such a concept cannot be approved under the Income-tax Act.
18. With respect to non-recognition of interest on loans and advances to M/s Share Medical Care, the learned DR submitted that a perusal of assessee's paper book at pages 70 to 72 clearly shows that the principal amount was not written off by the assessee in the books of accounts and only the interest part was not offered to tax. In fact, there had been some recovery of principal amount in the financial year 2000-2001 as is evident from page 72 of the paper book. On similar facts and circumstances, it has been herd by the ITAT, Hyderabad, in its order dated 10-8-2003 in I.T.A. No. 699/Hyd/2002 in the case of Shakuntala Rathi, that in the absence of any evidence to prove that the recovery of debt was in doubt, interest automatically accrues and is assessable to tax. Decision of the Calcutta Bench of the ITAT in the case of Jayanthi Commerce, 61 ITD 183, and the decision of Hon'ble Calcutta High Court in 202 ITR 839 and that of Hon'ble Rajasthan High Court in 203 ITR 1001, also advance the same principle.
19. As regards unpaid interest of Rs. 2,47,123 in the case of Godavari Capital Ltd., the learned DR argued that the letter filed at page 66 of the assessee's paper book, showing that there was a mutual settlement between the parties as per which the amount was written off, was not found on the record of the Assessing Officer. The contentions of the letter had not been considered by either the AO or the CIT (A) and, therefore, the said letter should not be admitted as evidence. On the legal issue, the learned DR placed reliance upon the decision of Hon'ble A.P. High Court in the case of N. Annaji Rao, 97 ITR 265, as per which voluntary surrender of debt does not enable the assessee to claim an amount as bad debt.
20. Countering the arguments of the learned DR, the learned counsel for the assessee submitted that the contentions made on behalf of the assessee have not been properly and/or correctly appreciated by the Revenue. He submitted that it is not the case of the assessee company that the income by way of interest or finance charges had already accrued in its case and that it is trying to avoid liability to tax by making reference to Section 145 of the I.T. Act or the provisions of Chapter III B of the Reserve Bank of India Act, 1934; and/or the directives issued by the RBI under Section 45JA of the RBI Act. The case of the assessee company has all along been that in the facts and circumstances of the instant case the interest and finance charges cannot be said to have accrued in the real sense having regard to the undisputed fact that the realization of principal itself is doubtful of recovery. The bona fides of the Board of Directors in coming to the conclusion at the Board meeting held on 28-1-1999, to the effect that the interest and finance charges cannot be said to have accrued on account of continued failure on the part of the concerned debtors in making payments of dues in terms of the agreement and the principal amount being itself doubtful of recovery, has not been doubted either by the AO or the CIT (A). In fact, this was the case pleaded by the assessee company in the notes to its audited accounts, the written notes submitted before the AO (pp. 32 & 33 of PB as well as assessee's letter dated 7-3-2002 addressed to the AO at pp. 29-33 of PB). Both the AO and the CIT (A) only referred to the mercantile system of accounting followed by the assessee company and observed with reference to the decisions cited in their respective orders that under mercantile system of accounting income accrues from day to day and non-receipt by the assessee is no ground to affect such accrual. Both the AO and the CIT (A) proceeded on an erroneous basis. The learned counsel further submitted that it is now well settled through repeated judicial pronouncements that the accrual must be real taking into account the actuality of the situation. Whether an accrual has taken place or not must be judged on the principal of the real income theory taking the probability or improbability of realization in a realistic manner. When the principal amount itself is doubtful of recovery, interest and finance charges cannot be said to accrue merely on the ground that the assessee has been following the mercantile system of accounting. The question whether real income has materialized to the assesses has to be considered with reference to commercial and business realities of the situation and not with reference to the assessee's system of accounting. The decision of Hon'ble Supreme Court in State Bank of Travancore v. CIT, 158 ITR 102, went against the assessee only because of the conduct of the assessee bank in continuing to debit the debtors account with the interest and crediting such interest to interest suspense account. The Hon'ble Supreme Court in that case laid great emphasis on the concept of real accrual taking into account the actuality of the situation, viz. the probability or improbability of realization in a realistic manner. In the instant case, the assessee had not provided for interest or finance charges to the account of the concerned debtors as was done by the assessee in the case before Hon'ble Supreme Court. The learned counsel further submitted that the Directives issued by the RBI under the RBI Act only support the concept of real accrual insofar as it says that once the account of a debtor becomes NPA, the interest of finance charges cannot be recognized unless it is actually received. In other words, the directives of the RBI do not go against the provisions of either Section 5 or Section 145 of the Income-tax Act, 1961.
21. The learned counsel also distinguished the other decisions cited by the learned DR. He further submitted that in UCO Bank v. CIT, 237 ITR 889, the apex court laid emphasis on the objectives of the Circular dated 9-10-1984 issued by CBDT that if there is no receipt of interest for 3 years, the interest on such doubtful loan cannot be recognized unless received. This fact is noted at the bottom of page 900 of the report. Dealing with this issue at the top of page 901, the apex court further observed that in their view there was no inconsistency or contradiction between the circular so issued and Section 145 of the I.T. Act and the circular only clarifies the way in which the interest amounts are to be treated by the lender in his accounting policy. The learned counsel submitted that the directives issued by the RBI are on the same lines. These directives define when a debtor's account should be treated as NPA and state that when it becomes NPA, no interest should be recognized until it is actually received. The directives issued by the RBI are neither inconsistent nor contradictory to Section 145 of the I.T. Act. When the assessee company follows such directives issued by the RBI, it is not acting on its ipse dixit but it is bound to follow such directives. Such directives lay emphasis on reality of accrual.
22. As regards the decision of Special Bench of the ITAT, Hyderabad, in the case of Nagarjuna Investment Trust, 65 ITD 17 (SB), referred to by the learned DR, the learned counsel for the assessee submitted that the said decision has no application in the instant case. He submitted that there the assessee had been apportioning each instalment received by it into principal and interest depending upon the period during which the entire instalments were payable. The Special Bench held that the apportionment carried out by the assessee was proper. In paragraph 26 of its order, the Special Bench has set out the various principles of law vis-a-vis Sections 4, 5 and 145 of the I.T. Act. The learned counsel submitted that there is no quarrel with those principles which are well settled, but the issue in the instant case is quite different.
The issue here is whether there has been any accrual of interest/finance charges in the real sense in the facts and circumstances of the instant case and the decision of the Special Bench in Nagarjuna Investment Trust case does not deal with this issue.
23. As regards Government's Accounting Standard reported in 218 ITR (St) 1, the learned counsel for the assessee submitted that it only helps the assessee insofar as it talks about prudence as a major consideration in the matter of adopting accounting policy as explained in paragraph 4(a) thereof and the fact that it also talks about change in accounting policies being made if it is required by statute. He further submitted that the term extraordinary items" in paragraph 13(c) of the said standard, referred to by the learned DR, has been dealt with in paragraph 8 thereof and this paragraph relates to disclosure in the profit and loss account. He submitted that the extraordinary item as dealt with in that standard has no connection with the issue involved in the instant case.
24. The learned counsel also submitted that the letter dated 14-7-1998 which confirms that the assessee company received from M/s Godavari Capital Rs. 2 lakhs by cheque dated 15-7-1998 in full and final settlement of their aggregate dues in the sum of Rs. 4,47,123 was already before the AO as well as the CIT (A) and it was not a new evidence filed before the Tribunal as alleged by the learned DR.25. The learned counsel further submitted that the decision of the Delhi Bench of the Tribunal in the case of TEDCO Investment and Finance Services, 87 ITR 298, is a direct decision, which deals with the effect of the RBI's directives vis-a-vis income-tax assessment of an NBFC, as that of the assesses company. It is not the case of either the AO or the CIT (A) that the case of the assessee does not fall within the purview of the directives dated 31-1-1998 issued by the RBI. Their case on the other hand is that the said directives of the RBI cannot override the Income-tax Act. The Tribunal in the aforesaid case has already held that the directives of the RBI have full binding force and would also override the Income-tax Act, 1961, in view of Section 45Q of the RBI Act, 1934. The said decision of the Delhi Bench being the only decision on this point, the learned counsel submitted, the Tribunal at Hyderabad, even on grounds of consistency and uniformity, should follow that decision and decide the instant appeal in favour of the assessee company.
26. We have heard rival contentions and considered the arguments carefully. We have also gone through the papers on record as well as the orders of the authorities below. In the light of the various pronouncements relied upon by both the parties and all the facts and circumstances of the case, we hold as follows.
27. The assessee has been following the prudential norms prescribed by Reserve Bank of India from the asst. year 1995-96 onwards. The income from non-performing assets, which are determined on the basis of the directions from the RBI, has not been recognised from the asst. year 1995-96 to the asst. year 1998-99. During the present assessment year i.e. 1999-2000, the same method of accounting is being followed by the company. There is no change in the method of accounting during the assessment year under consideration.
"145. (1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to the provisions of Sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in Sub-section (1) or accounting standards as notified under Sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in Section 144." Central Board of Direct Taxes, vide Notification No. S.O. 69(E) dated 25-1-1996 [218 ITR (St) 1], notified the following standard :- "A. Accounting Standard I relating to disclosure of accounting policies: (1) All significant accounting policies adopted in the preparation and presentation of financial statements shall be disclosed.
(2) The disclosure of the significant accounting policies shall form part of the financial statements and the significant accounting policies shall normally be disclosed in one place.
(3) Any change in an accounting policy which has a material effect in the previous year or in the years subsequent to the previous years shall be disclosed. The impact of, and the adjustments resulting from, such change, if material, shall be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the previous year but which is reasonably expected to have a material effect in any year subsequent to the previous year, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted.
(4) Accounting policies adopted by an assessee should be such so as to represent a true and fair view of the state of affairs of the business, profession or vocation in the financial statements prepared and presented on the basis of such accounting policies. For this purpose, the major considerations governing the selection and application of accounting policies are the following, namely :- (i) Prudence. - Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information; (ii) Substance over form. - The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form; (iii) Materiality. - Financial statements should disclose all material items, the knowledge of which might influence the decisions of the user of the financial statements.
(5) If the fundamental accounting assumptions relating to going concerns, consistency and accrual are followed in financial statements, specific disclosure in respect of such assumptions is not required. If a fundamental accounting assumption is not followed, such fact shall be disclosed.
(a) "Accounting policies" means the specific accounting principles and the methods of applying those principles adopted by the assessee in the preparation and presentation of financial statements; (b) "Accrual" refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate; (c) "Consistency" refers to the assumption that accounting polities are consistent from one period to another; (d) "Financial statements" means any statement to provide information about the financial position, performance and changes in the financial position of an assessee and includes balance sheet, profit and loss account and other statements and explanation notes forming part thereof; (e) "Going concern" refers to the assumption that the assessee has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the business, profession or vocation and intends to continue his business, profession or vocation for the foreseeable future."CIT v. U.P. State Industrial Development Corporation, 225 ITR 703, as per Head Note, held as follows:- "In order to determine the question of taxability, well settled legal principles as well as principles of accountancy have to be taken into account. It is a well accepted proposition that "for the purposes of ascertaining profits and gains, the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statutes"." Hon'ble Supreme Court, in the case of Godhra Electricity Co. Ltd. v.CIT, 225 ITR 746, at pages 757 & 758, held as follows:- "In CIT v. Shoorji Vallabhdas and Co. [19621 46 ITR 144, 148 (SC).
It has been laid down : "Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a hypothetical income, which does not materialise." This principle is applicable whether the accounts are maintained on cash system or under the mercantile system. If the accounts are maintained" under the mercantile system what has to be seen is whether income can be said to have really accrued to the assessee-company. In H.M. Kashiparekh and Co. Ltd. v. CIT [1960] 39 ITR 706, the Bombay High Court had said : "Even so, (the failure to produce account books), we shall proceed on the footing that the assessee-company having followed the mercantile system of accounting, there must have been entries made in its books in the accounting year in respect of the amount of the commission. In our judgment, we would not be justified in attaching any particular importance in this case to the fact that the company followed the mercantile system of accounting. That would not have any particular bearing in applying the principle of real income to the facts of this case." The said view was approved by this court in CIT v. Birla Gwalior (P.) Ltd. [1973] 89 ITR 266 where the assessee maintained its accounts on the mercantile system. In that case this court, after referring to the decision in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC), which was also a case where the accounts were maintained on the mercantile system, has said : "Hence, it is clear that this court in Morvi Industries' case [1971] 82 ITR 835 did emphasise the fact that the real question for decision was whether the income had really accrued or not. It is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income." In Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521, this court has said "Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act." In that case the court has approved the following principle laid down by the Bombay High Court in H.M. Kashiparekh and Co. Ltd. v. CIT [1960] 39 ITR 706, 707 : "The principle of real income is not to be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect of managing agency commission is made, agreed to or given on grounds of commercial expediency, simply because it takes place some time after the close of an accounting year. In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it. It will lay greater emphasis on the business aspect of the matter viewed as a whole when that can be done without disregarding statutory language. " In State Bank of Travancore v. CIT [19861 158 ITR 102 (SC), after considering the various decisions of this court, Sabyasachi Mukharji J. (as the learned Chief Justice then was), has said : "An acceptable formula of co-relating the notion of real income in conjunction with the method of accounting for the purpose of the computation of income for the purpose of taxation is difficult to evolve. Besides, any strait-jacket formula is bound to create problems in its application to every situation, it must depend upon the facts and circumstances of each case. When and how does an income accrue and what are the consequences that follow from accrual of income are well-settled. The accrual must be real taking into account the actuality of the situation. Whether an accrual has taken place or not must, in appropriate cases, be judged on the principles of the real income theory. After accrual, non-charging of tax on the same because of certain conduct based on the ipse dixit of a particular assessee cannot be accepted. In determining the question whether it is hypothetical income or whether real income has materialised or not, various factors will have to be taken into account. It would be difficult and improper to extend the concept of real income to all cases depending upon the ipse dixit of the assessee which would then become a value judgment only. What has really accrued to the assessee has to be found out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner and dovetailing of these factors together but once the accrual takes place, on the conduct of the parties subsequent to the year of closing, an income which has accrued cannot be made 'no income'." Further, at page 760 of the report, the apex court further held as under:- "The question whether there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity has to be considered by taking the probability or improbability of realisation in a realistic manner. If the matter is considered in this light, it is not possible to hold that there was real accrual of income to the assessee-company in respect of the enhanced charges for supply of electricity which were added by the Income-tax Officer while passing the assessment orders in respect of the assessment years under consideration. The Appellate Assistant Commissioner was right in deleting the said addition made by the Income-tax Officer and the Tribunal had rightly held that the claim at the increased rates as made by the assessee-company on the basis of which necessary entries were made represented only hypothetical income and the impugned amounts as brought to tax by the Income-tax Officer did not represent the income which had really accrued to the assessee-company during the relevant previous years. The High Court, in our opinion, was in error in upsetting the said view of the Tribunal." 28. The argument of the learned departmental representative that under the mercantile system of accounting the interest on the non-performing assets automatically accrues and should be considered as income, does not appeal to us, for the reason that mercantile system of accounting cannot be considered a "mere mathematical model", where "subjective" conclusions on readability or otherwise of an income have no place.
Recognition of interest income in this case was not made on the mere ipse dixit of the assessee. A regular method of accounting, as considered prudent by the Reserve Bank of India, has been followed consistently for more than 4 years and this method has been accepted by the Revenue in the earlier years. Such regularly employed method of accounting, in our considered opinion, cannot be disturbed unless profits and gains cannot be properly deduced therefrom, and unless the assessee had made such entries on a mere "ipse dixit". Accounting Standard I notified by the Central Government in pursuance of Section 145(2), mandates that "consistency" is a fundamental accounting assumption. "Prudence" and "substance over form" are the corner stones to the accounting policies to be adopted by an assessee. Accrual of income has to be judged from the realistic point of view.
Non-recognition of income on the ground that the income had not really accrued as the realisability of the principal outstanding itself was doubtful, is legally correct under the mercantile system of accounting, when the same is in accordance with A.S.-I notified by the Government.
The principle that is to be seen is whether the assessee's method of accounting violates Accounting Standards notified by the Central Government. The case of the Revenue is not that A.S.-I has been violated by the assessee. In fact, the Hon'ble Supreme Court's judgment in the case of State Bank of Travancore v. CIT, 158 ITR 102 (SC) was on the position of law prior to the Income-tax Act adopting Accounting Standards I and II from 25-1-1996, vide Notification No. SO-69(E). This notification came into effect from 1st day of April 1996 and accordingly applies to the asst. year 1997-98 and subsequent assessment years. The issue that is not in dispute is that the Accounting Policies adopted by the assessee are those that are mandated by RBI. The accounting policies mandated by RBI are not contrary to A.S. I notified by the Central Government. In fact, they define what is "prudence" and also require assessees to go by the substance of the issue rather than the form. [See para (4) of AS I and Prudential Norms issued by RBI.] The Revenue cannot require the assessee to change his method of accounting unless para 9 of AS II which reads as under, is satisfied [218 ITR (St) 1]:- (9) A change in an accounting policy shall be made only if the adoption of a different accounting policy is required by statute or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements by an assessee.
Thus, when the Revenue could not demonstrate that the consistent method of accounting followed by the assessee is in violation of AS I, the disallowance made on that ground cannot be sustained.
29. It is significant to note that the Assessing Officer has accepted the stand of the assessee-company in respect of the reversed finance income, recognised in earlier years, in the aggregate sum of Rs. 47,90,510. This reversal was done based on the NBFC Prudential Norms RBI Directions, 1998, issued by RBI on 31-1-1998. Thus, while accepting reversal, non-recognition based on the same guidelines is disputed by the Revenue.
30. Even otherwise, the Delhi Bench 'B' of the Income-tax Appellate Tribunal, in the case of TEDCO Investment & Financial Services (P.) Ltd. v. Dy. CIT, 87 ITD 298, dealt with the matter at length. The gist of that decision is as follows:- "Section 145 of the Income-tax Act, 1961, read with Sections 45Q and 45JA of the Reserve Bank of India Act, 1934 - Method of accounting -System of accounting - Assessment year 1998-99 - Whether RBI Act is a special Act applicable to a class of assessees as opposed to Income-tax Act, 1961 which is applicable to assessees at large which can be considered to be a general Act - Held, yes - Whether Chapter IIIB of RBI Act has an overriding effect on provisions of Income-tax Act, including Section 145 - Held, yes - Whether, therefore, income of assessee, a Non-Banking Financial Company (NBFC), from non-performing assets will not be assessed on accrual basis, even though assessee is following mercantile system of accounting - Held, yes -Assessee did not recognize as its income lease rentals, interest and bill discounting charges, which had not been realized for more than 6 months, in terms of NBFC's Prudential Norms (Reserve Bank Directions)"- Assessing Officer did not accept it as company had not been registered as non-banking financial institution with RBI -Assessing Officer also viewed that provisions of Income-tax Act were to be applied rather than any other contrary view taken by any notifications; therefore, he added same to income of assessee as income accrued in year under consideration - Whether addition made by Assessing Officer by ignoring provisions of Chapter IIIB of RBI Act and directions issued by RBI on prudential norms in exercise of powers vested under RBI Act, could not be sustained - Held, yes." This proposition is strengthened by the judgment of Hon'ble Supreme Court in Peerless General Finance & Investment Co. Ltd. and Anr. v.Reserve Bank of India (1992) 2 SCC 343, paragraphs 13 & 14 at pages 362-363, Paragraph 52 at page 388, Paragraph 53 at page 389 and paragraph 60 at page 391, wherein it was observed that these directives issued by the RBI to non-banking institutions under Chapter IIIB of the said Act were statutory regulations. This principle was reiterated in RBI v. Peerless General Finance & Investment Co. Ltd. (1996) 1 SCC 642.
The NBFC's are bound to comply with such directions and non-compliance thereof visits them with penal action. Thus, the accounting policies and the consistent method of recognizing income adopted by the assessee are not merely on its "ipse dixit", but are in consonance with statutory regulations, and it cannot be said that such accounting policies do not result in representing a true and fair view of the state of affairs of the business.
31. As our view is in consonance with the view of the Delhi Bench of the Tribunal, we follow the same and uphold the contention of the assessee and allow this ground of appeal. Thus, the addition of Rs. 1,23,59,180 is hereby deleted.
32. On the issue of inclusion in total income of Rs. 2,47,123 being unpaid interest from Godavari Capital Limited, the learned DR submitted that the letter given at page 66 of the paper book, showing that there was a mutual settlement between the parties as per which the amount had been written off, was not considered either by the AO or by the CIT (A). In these circumstances, we deem it proper to set aside the issue to the file of the AO for considering this document and disposing of the issue in accordance with law.
33. The other ground taken by the assessee in this appeal relates to disallowance of legal expenses of Rs. 21,84,009 incurred for conducting legal proceedings against the defaulting debtors. Before the AO, the assessee filed a letter stating that they incurred legal expenses of Rs. 21,84,009 during the previous year relevant to the asst. year under consideration for conducting legal proceedings against the defaulting debtors for recovery of the dues. The assessee stated that the amount was not debited to P & L account for the year ended 31-3-1999 and is now claimed as deduction in the return of income. It was also mentioned that the same was carried forward in the respective parties' account.
The assessee claimed that as the expenditure was incurred during the year wholly and exclusively for the purposes of business, the same should be allowed as a deduction in computing the total income.
According to the AO, the act of the assessee showed that legal expenses incurred in the process of pursuing realization of amounts due from debtors were realizable from the debtors and were not considered as expenditure of the assessee in its regular books of account. That was why the assessee transferred the amount to the respective debtors' account instead of debiting to P&L account under the head legal expenses. As the assessee did not write off the expenditure by debiting to P&L account and as the same appeared in the respective debtors' account as amount realisable, the AO held that the same could not be allowed as an expenditure under Section 37(1) of the Income-tax Act, 1961. The CIT (A) was of the view that by making a claim in the computation statement without duly reflecting the same in the books of account would lead to an incongruent situation of allowing expenditure without making an entry in the books of account; such procedure was not permissible as per law and that to claim an expenditure under Section 37(1), the amount was to be debited to the profit and loss account and not apportioned and added to the debts receivable. The CIT (A), therefore, held that the AO was correct as per law in disallowing the claim and upheld the action of the AO in this regard.
34. The learned counsel for the assessee referred to paragraph 6 of the statement of facts at page 18 of the paper book and letter dated 5-3-2002 addressed by the assessee to the AO at page 75 and details of legal expenses at pp. 76-79 of the paper book. He submitted that the legal expenses in question had been actually incurred by the assessee company during the previous year relevant for the asst. year under appeal in filing cases against the debtors concerned for realization of the dues. The legal expenses were debited by the assessee company in its books of account to the account of each of the relevant debtors instead of charging the same to the debit of profit and loss account.
Legal expenses were carried to the debtors' account in order to keep a track of expenditure incurred in respect of the parties. Awarding of costs to the assessee-creditor was a matter wholly in the discretion of the law courts. The legal expenses had been actually incurred by the company wholly and exclusively for its business purposes. The learned counsel, therefore, submitted that these expenses are admissible and the mere fact that these were not charged to the profit and loss account was no ground to disallow the same. According to him, the treatment of an expenditure in the books of account in a particular manner or existence or absence of an entry in the books of an assessee is neither determinative nor decisive for tax purposes. In this connection, he relied upon the following decisions:- iii) Kedarnath Jute Manufacturing Co. Ltd. v. CIT (1971) 82 ITR 363, 367 (SC) 35. The learned DR submitted that the assessee had debited the expenses to the respective parties' account and not written off the same in the P&L account. He stated that actually the correct position is that the expenses go to the debtors' account and are to be realized from them on final judgment, and if the claim is rejected by the court, it can be claimed as crystallized expenditure in the relevant previous year when proceedings come to an end. That is why there was no debit in the P&L account by the assessee. He referred to the decision of Hon'ble Andhra Pradesh High Court in the case of Boorugu Nagaiah Rajanna v. CIT, 114 ITR 350, wherein it was held: "Applying the same principle, it must be held that, in the light of this decision of the Gujarat High Court, with which we agree, until the final determination of the amount of costs till the end of the trial court stage was reached, it could not be predicted what the amount of expenditure would be and, therefore, the assessee was justified in claiming the entire amount of Rs. 69,190 as a deductible expenditure in the year of account relevant to the assessment year 1996-97." The learned DR submitted that applying the aforesaid principle, litigation expenses can actually be said to have crystallized only in the year in which the suit filed by the assessee is decided, and not in the years in which the litigation was pending. In normal circumstances, the assessee would recover litigation expenses from the debtors at the end and thus there would be no expenditure arising to the assessee.
However, in case the assessee loses the suit, the expenditure can be claimed in that particular year as an ascertained expenditure. Thus, there is no validity of the claim made by the assessee that the litigation expenses debited to the parties' account should be allowed as expenditure in the hands of the assessee without debiting the same to profit and loss account. No details of the expenses had also been filed. In view of this, the learned DR argued that the ground of appeal taken by the assessee on this issue has to be dismissed.
36. In reply, the learned counsel for the assessee submitted that the stand taken by the learned DR is wholly devoid of any merit. He further submitted that the decision of Hon'ble A.P. High Court cited by the learned DR has no application in the facts and circumstances of the instant case. From a reading of the last paragraph at page 365 of the report, it may be noted that the legal expenses of Rs. 69,190 had not been incurred by the assessee in that case. The said expenditure had been incurred by the Hindu undivided family in different years and after the decision of the City Civil Court on 30-12-1964, the said expenditure was taken over through a transfer entry by the assessee firm from the said HUF. It was in these circumstances that the High Court held that the liability of the assessee firm to pay the said sum of Rs. 69,190 by way of legal expenditure was not allowable prior to the asst. year 1966-67. At the top of page 366, the court clearly held that the expenditure in question was clearly allowable as a revenue expenditure in the asst. year 1966-67. It is true that the court also noted at page 366 of the report that till the end of the Trial Court stage was reached, it could not be predicted what the amount of expenditure would be. But, in the facts of that case, the court found that till the asst. year 1966-67, the assessee could not have claimed such expenditure as these had not been incurred by it but had been incurred by the HUF. The learned counsel submitted that the said decision of the Hon'ble High Court does not help the revenue in the facts and circumstances of the instant case. Here, the legal expenses have all along been incurred by the assessee company. The expenses had been incurred wholly and exclusively for business purposes of the assessee in the year under appeal. In case the assessee company is able to recover any part of such legal expenses by way of costs to be awarded by the court on finality of the litigation with the debtors, the same could be taxed in its hands under Section 41(1) of the Income-tax Act, 1961.
37. We have considered rival submissions. The assessee had not debited the amount of Rs. 21,84,000 to its profit and loss account. Under the method of accounting being regularly followed by the assessee, this expenditure had not been considered as one which had accrued during the year. When we were dealing with recognition of income in the form of interest, lease rental and finance charges on hire purchase agreement, emphasis was laid on the accrual of the income based on the method of accounting regularly employed by the assessee. We have also held that the method of accounting was consistent and the conduct of the party in treating the income in a particular manner is a material evidence as to whether the income has accrued or not. When on the issue of recognition of income we have given emphasis to AS I, concepts such as "consistency", "prudence", "method of accounting" etc. can it be said that when it comes to expenditure, the method of accounting etc. has no relevance? We do not think so. The only issue in both these cases is as to "what is the time of accrual". Applying the same principle to the accrual of expenditure, we have necessarily to hold that the expenditure had not accrued to the assessee during the year based on the consistent method of accounting being followed by the assessee.
Accrual of expenditure or income under the mercantile system cannot be different under the Income-tax Act and under the Companies Act. What has not accrued under the Companies Act cannot be said to have accrued under the Income-tax Act. The assessee had followed Accounting Standard I and found it prudent that no provision need be made under the mercantile system of accounting for this expenditure/liability during this particular assessment year. Thus, as per the company's method of accounting, this expenditure had not crystallized during the relevant previous year. We, therefore, uphold the contention of the Revenue and dismiss this ground of appeal raised by the assessee, by applying the same reasoning as we have adopted as to the time of accrual of income, in the case of interest on N.P.As. The assessee may claim the expenditure as and when the expenditure crystallises as per the method of accounting regularly employed by him.