TMI Blog2001 (2) TMI 303X X X X Extracts X X X X X X X X Extracts X X X X ..... ere are few issues in both the appeals that are specific to an assessment year and by means of this order we first shall deal with these independent issues in the order in which it has been so raised in the grounds of appeal. These independent issues shall be dealt with year by year. ASSESSMENT YEAR: 1995-96 3. The issue that is raised is with reference to the claim for deduction from the total income of an amount of Rs. 2,78,000 under the head 'provision for doubtful debts'. The Assessing Officer [AO for short] did not allow the claim for the only reason that it was not written off in the books as is required by section 36(1)(vii) of the Act. The counsel for the appellant company Mr. Vijayaraghavan relied on the Gujarat High Court in Vithaldas H. Dhanjibhai Bardanwala v. CIT [1981] 130 ITR 95 and submitted that Court had appreciated the provision made by debit to Profit Loss Account and credit to a Reserve Account as equivalent to write off and that it is unnecessary to give credit to individual parties account. He also made reliance on the jurisdictional High Court in CIT v. Srivinayaga Pictures [1986] 161 ITR 65 (Mad.) for highlighting the proposition that consequent upon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the assessee on 28-1-1998 that read as follows: "amount of interest against General Reserve-II, Overseas Sanmar Financial Limited had taken in earlier years from Financial Institution. Consequent to the reduction of interest rate, it felt advantageous to cancel/repay and swapped in against new loans at lower rates. Due to foreclosure of loan, the assessee company was required to pay foreclosure premium of Rs. 56,15,126 to the financial institution. This is a one-time payment made to reduce the financial burden in the form of interest commitment at a lower rate in future period. In other words, the debit to profit and loss account by way of interest on account of this would be lower in the future years." Assessing Officer however was not impressed and rejected the claim for deduction of the foreclosure premium. The assessee raised an argument before CIT(A) in appeal that this may be treated as processing charge for the fresh loan. CIT(A) considered this submission with reference to the debentures issued at a discount and placing reliance on the ruling of the Apex Court in Madras Industrial Investment Corpn. Ltd. v. CIT [1997] 225 ITR 802 he concluded that similar to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness decision and therefore, it is laid out wholly for the purposes of its business. This itself is sufficient for allowing the claim in full in the year in which it was incurred. In Madras Industrial Investment Corpn. Ltd.'s case the assessee did not make its claim for deduction of entire amount of discount allowed on debenture issues but only to the extent of a portion that it arrived by dividing the amount of discount by the number of years of life of debenture. Thus, the Apex Court was not addressed on the allowability of the entire amount in the year of incurring and therefore, there was no ruling on that point. However, the decision Sivakami Mills Ltd.'s case clearly goes to show that the guarantee charges paid for a loan that is to run for a few years is allowable on the basis of the contract being effected in the year. In the other case, Madras Auto Service (P.) Ltd., the lessee demolished the entire building that was taken on a lease of 39 years and constructed a new building in its place on the understanding that on expiry of the lease the building as reconstructed would be handed over to the lessor for which consideration a lower rent was agreed to by the lessor. The c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f accounting that was followed by it. The assessee was following 'Sum of Digits' [SOD for short] for determining its income from hire purchase transactions. This was changed to 'Capital Recovery' or 'Internal Rate of Recovery' [IRR for short] method. This change that was brought about the assessee covered the present assessment year and some earlier assessment years as well. The claim for reduction in the income from hire purchase was for Rs. 1,16,47,467 of which Rs. 10,90,461 was relatable to the year under appeal. The assessee justified for resorting to this change in method of accounting before the Assessing Officer as under: "The assessee company has during the previous year relevant to the above assessment year changed its method of income recognition on hire purchase transaction from 'sum of digits' to 'capital recovery method'. Capital recovery method recognizes income to provide periodic rate of return on net investment outstanding. This method calculates income based on investment outstanding at any point of time. Hire money accrued every month reduced the investment outstanding, the income for the next month is accrued on the reduced investment outstanding. The 'c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt at best could be only for that amount that related to the year under appeal and this is Rs. 10,90,461. However, it needs to be appreciated whether an assessee could choose to change his method of accounting for tax purposes. To our mind the Act goes by the fundamental fact that it is to start from the business activity in the commercial sense and to the commercial income so shown in the books adjustments covering relief's, deductions, disallowances are made for computing the total income of the assessee. Section 145 of the Act talks of computing the income from the books maintained or estimation of income where the correct income could not be computed from the books. Considering the fact that it is not the case of the appellant company that its true or correct income could not be computed from its books of account, the change resorted to for tax purposes only, we are of the opinion that the claim is not tenable and deserves to be rejected which we do. Accordingly this issue is decided in favour of the revenue and against the assessee. 8. The last of the issue is with reference to the levy of interest under section 234B of the Act and this was stated as only consequential and h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ital adequacy and concentration of credit/investments". He also noted the claim with reference to that part of the circular of RBI that dealt with provisioning for loans and advances and reproduced para 4 of the said circular. He referred to the decision of Calcutta High Court in CIT v. National Insurance Co. Ltd. [1996] 221 ITR 778 in which it was held that the interest on sticky advances credited to suspense account and not treated as income in computing the income of the insurance company was proper and observed that the computing the income of the insurance company is specifically provided in section 44 of the Act. CIT(A) also observed that the circular issued by RBI was for proper governance of NBFC and its sound financial condition and is so issued for giving a realistic picture of its income and assets. He finally observed that the guidelines though may govern the functioning the NBFC but because there is no provision under the Act as provided for in the case of banks like in section 36(viia) of the Act, the claim for deduction based on the guidelines could not be allowed. 10. Mr. Vijayaraghavan, the counsel for the assessee filed a paper book that contained the various ci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd many more. He contended that RBI is an authority that controls the functioning of banking and non-banking financial companies and it keeps a watch on the functioning of these institutions for the sole purpose of making sure that these institutions remain sound that would also make the country's finances good. He pleaded that NBFC are required to be registered and submit reports on its functioning which would be examined critically by RBI based on which it may allow or relax in regard to the extent of acceptance of deposits which deposits are the prime source of functioning of NBFC. He contended that the term 'non-performing assets' had been coined by RBI to bring the true picture of financial soundness of each advance or loan given by NBFC. He submitted that the loan or advance which did not yield regular income and regular repayment of principal fall into the category 'non-performing asset' and it points out the fact to the extent the loans or advances are grouped under the head 'non-performing assets' the asset may not be realizable resulting in loss to NBFC. Such loans where recovery had been irregular or recovery had been made possible because of the intervention of the Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itution that examines such cases and declares them as unfit for carrying on the business or issues orders, for restructuring them with additional finance or re-scheduling of finance given together with waiver of interest payable. He pleaded that the circulars, issued govern the functioning or operations of NBFC and has been issued for achieving safe business practices and therefore, are to be treated as an order that only requires to be followed by NBFC. He pleaded that various courts recognize hybrid system of accounting and this recognition is specific to banking companies. He also pointed out that the Apex Court in UCO Bank v. CIT [1999] 237 ITR 889 had appreciated the value of the circulars issued by RBI for the functioning of the banks as to ensure proper administration of the statute with the effect of relaxing the rigour of law and for providing uniform application of law consonant with the concept of income. He contended that NBFC that are required to adopt and follow the circulars issued by RBI have only followed the ruling of the statutory authority. He pleaded in UCO Bank's case the Apex Court was concerned with the system of accounting of income including the income f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncome is the same as is recognized by every normal person carrying on commerce and trade and all that the Act does is to provide for certain refinements specific to that Act and this feature has been recognized by the courts as in the interest of the country. He made a reference to the decision of Andhra Pradesh High Court in N. Annajee Rao Bro. v. CIT [1974] 97 ITR 265 for pressing his view that the compliance by assessee to the circular issued by RBI is voluntary for seeking better placement insofar as it concerns with improved deposit mobilization and no more, and therefore, applicability of such circulars should be confined to this aspect of deposit invitation and not with reference to the determination of true income. He pleaded that the claim of the assessee for income being assessed on cash basis if allowed would lead to assessee never being taxed for its real income. The norm as issued by RBI is mere route guide and is not to be treated as a statute or law. He submitted that he has no quarrel with the fact that RBI is a statutory body established for governing the functioning or regulating the banking sector of this country and because of this inherent power that it is ve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is given hereunder. The title of the circular read--'Financial Companies--Prudential Norms for income recognition, accounting standards, provisioning for bad and doubtful debts, capital adequacy and consideration of credit/investments' and this was to cover and govern NBFC with net owned funds of Rs. 50 lakhs and above and registered with RBI. "In Circular Letter No. DFC(COC) 828.174.92.93 dated 12-4-1993, the non-banking financial companies (NBFCS) and residuary non-banking companies were advised that in pursuance of the recommendations of the working group on Financial Companies (SWG) the RBI would be introducing capital adequacy norms based on risk weights for different type assets and off balance sheet items of liabilities. The financial companies were also advised that prudential norms for income recognition, transparency of accounts and provisioning of bad and doubtful debts as also credit concentration to single and group borrowers would be prescribed The bank after appropriate consideration and consultation, has now decided to introduce these prudential norms. A note containing the norms in the form of guidelines on these aspects is enclosed (Annexure 1). Your company sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n, Para IV covers provisioning loans and advances and so on. For the instant case the prescription for provisioning of loans and advances is only relevant but the concept of non-performing assets also needs to be appreciated which is contained in the income recognition concept and therefore we reproduce para 1 covering income recognition and para IV covering provisioning loans and advances for the sake of facility. Para II Income Recognition The policy on income recognition to be objective should be based on record of recovery. 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 therefore should be recognized only when it is actually received. NPA is an asset in respect of which interest has remained unpaid or has become 'past due'. An amount is to be treated as 'past due' when it remains unpaid for 30 days beyond the due date. Interest on NPAs should not be booked as income if such interest has remained outstanding for more than six months on and from 31-3-1995. The basis of treating a credit facility as NPA should be as under:-- (a) Term loan for on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g shows that the circular is to be applied religiously. The word 'prudent' is defined as 'avoiding risks and uncertainties and careful'; the word 'Norm' is defined as 'a norm is an accepted standard or a way of behaving or doing things that more people agree with'; and the word 'guideline' is defined as 'a piece of information intended to advise people on how something should be done or what something should be' [Cambridge International Dictionary of English--low priced edition at pages 1140, 960 and 630 respectively]. The words 'guideline' and 'norms' apparently mean the same thing. The reading of the above reproduced portion of the norms issued by RBI indicate that they are compulsorily to be followed by NBFC as is mentioned for provisioning of doubtful advances as "taking into account the time-lag between an account becoming doubtful of recovery, its recognition as such, the realization of the security and the erosion over time in value of security charged, it has been decided that NBFCs should make provision against sub-standard assets, doubtful assets and loss assets". The circular as reproduced above states that NBFC would be allowed to mobilize deposits from various source ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting in the true value of the security to be depleted. The directive is specific to the effect of appreciating the problems of finance companies like the time that may be taken for a debt to become irrecoverable, its realization that it has reached that stage of being known as doubtful and erosion in security value that provision is directed to be made in certain percentages. Some loss assets to be provided at 100%, some 100% of the amount out-standing, doubtful assets to be provided for at 100%, certain others between 20% to 50% considering the number of years like less than a year, less than three years and more than three years. According to RBI's directive the NBFC after following the norms as prescribed would show its true financial position that would be a safe ground to walk on by the public in rendering a helping hand by coming forward to its call for keeping their money in deposit with NBFC. The question is that the safety norm prescribed by RBI for governance of NBFC, could it be adopted in computing the income under the Act. The claim of the Department is that the provision for doubtful advances could not be allowed because section 36(1)(viia) talks of provision of dou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be made by NBFC if it has to continuously get the patronage of RBI and remain in business by avoiding unscrupulous methods. Income-tax Department is one wing of the Finance Ministry to which RBI is also attached and therefore when one of its wings controls the finance of the economy by issuing guidelines required to be followed by NBFC, the other wing in our view must accept the action of NBFC as a legal, valid and bona fide one. The consequence is the share in the true income of NBFC would have to be restricted to that part that is arrived at after allowing for provision for doubtful and non-performing assets. RBI's directive to account for the income on cash basis is an appreciation of the fact that it does not make any sense to account the income on accrual basis giving no credence to actual recovery and later allowing deduction for irrecoverable debts including debts that could not be recovered in full from the security provided because of erosion in the value of the security. The Department that is partner in income earned by companies and other persons to our mind should accept the concept of income as directed to be shown by RBI and after deducting for provision for doubtf ..... X X X X Extracts X X X X X X X X Extracts X X X X
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