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2015 (11) TMI 122 - MADRAS HIGH COURT

2015 (11) TMI 122 - MADRAS HIGH COURT - [2015] 378 ITR 533 - Accrual of income - Additional Finance Charges (AFC) also known as Overdue Charges (ODC) - Taxation in the light of Section 145 - Held that:- In the instant case, the Revenue is not in a position to show that due to the change of accounting method, the Revenue suffered loss. Admittedly, there is no finding to that effect in the assessment order. We also find that the change in method of accounting has not caused any loss to the Revenue .....

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the light of the decision of this court in the case of Annamalai Finance (2004 (10) TMI 51 - MADRAS High Court), we find no justification or good reason why we should reject the claim of the assessee. We have no hesitation to hold that collection and accrual of AFC happen simultaneously in the present case as and when received, as has been held by this Court. Hence, AFC cannot be treated as income on accrual basis.

Following the decision of this Court reported in CIT V. Annamalai Fina .....

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ax Case (Appeal) Nos.1222 and 1225 to 1228 of 2007 - Dated:- 15-6-2015 - MR. R.SUDHAKAR AND MS. K.B.K.VASUKI, JJ. For The Appellant : Mr.J.Narayanasamy Standing Counsel for Income Tax For The Respondent: Mr.R.Sivaraman COMMONJUDGMENT (Judgment of the Court was delivered by R.SUDHAKAR,J.) All the above Tax Case (Appeals) are filed by the Revenue as against the order of the Income Tax Appellate Tribunal raising a common issue. The key issue that needs to be decided in the above appeals is the mann .....

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of 2007) and 2000-2001 (T.C.(A) No.1227 of 2007). In all these assessment years, the assessee was accounting AFC on accrual basis in the books of accounts maintained for the purpose of the Companies Act, whereas, for the purpose of Income Tax, it was accounted on cash basis. The Assessing Officer was of the view that the respondent/assessee was following mercantile system of accounting and therefore, it was bound to show income arising out of AFC on accrual basis and therefore, additions on acco .....

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purpose of Companies Act, that amount should be reflected for the purpose of income tax as well. 3. Aggrieved by the said order of the Assessing Officer, the assessee preferred appeals before the Commissioner of Income Tax (Appeals). The Commissioner of Income Tax (Appeals) deleted the addition on the ground that the assessee was entitled to show the income arising out of AFC as and when the said income is received. In other words, the Commissioner of Income Tax (Appeals) rejected the stand of t .....

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for the purpose of income tax, it will show only the actual AFC amount received as towards income, more so, in a case where the assessee is admittedly following mercantile system of accounting. If it had accrued for the purpose of profit and loss account submitted in terms of the Companies Act, AFC should be deemed to have accrued for the purpose of income tax. On this premise, the case was urged before the Tribunal. 5. The Tribunal, however, placed much emphasis on the earlier decision of the T .....

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unts, one for the purpose of income tax and the other for the purpose of compliance with the other Act, viz., Companies Act or Central Excises and Salt Act, the Tribunal, referring to Section 115J, 115JA and 115JB, came to hold that wherever such a situation arises, special provision has been made. 7. The Tribunal placing much reliance on the decision of this Court in the case of Annamalai Finance Ltd. (supra), held that the amendment to Section 145 of the Income Tax Act did not have any effect .....

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aid order of the Tribunal, the Revenue is before this Court. 9. Mr.J.Narayanasamy, learned Standing Counsel appearing for the Revenue argued in extenso as follows: In order to explain the nature of the Department s claim on the tax on AFC, he suggested an illustration as follows: If the assessee had financed a sum of ₹ 1,20,000/- at the rate of interest at 20% per annum, the instalment will be ₹ 10,000/- per month; in case of default on the monthly instalment, the assessee charges &# .....

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r the purpose of the Companies Act in the same year. However, for the purpose of income tax, the assessee is not maintaining or following mercantile system and has not offered AFC for assessment on mercantile basis. In view of the specific provisions of Section 145 of the Income Tax Act, the assessee ought not to have followed cash system of accounting for this transaction. Having opted to mercantile system of accounting, the AFC become liable to tax as in the case of EMI. In effect, as and when .....

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which reliance has been placed by the Tribunal stands distinguished on facts, inasmuch as the assessee during the assessment year did not account the AFC in the books of accounts maintained under the Companies Act as well as under the Income Tax Act; therefore it stands on a different footing. Insofar as the present assessment years are concerned, the assessee had accounted AFC under the Companies Act, but it did not account the same for the purpose of income tax. This distinguishing factor, th .....

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nd in accordance with sub-section (2) of Section 145 of the Income Tax Act. 12. The further contention of the learned Standing Counsel appearing for the Revenue is that the concept of real income as contended by the assessee cannot be applied to the present case, since there is no material shown by the assessee that AFC income is impossible of realisation; in any event, the assessee is entitled to claim it as bad debts in the subsequent years if the AFC is not realisable. 13. In support of his c .....

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Mr.R.Sivaraman, learned counsel appearing for the assessee/respondent submitted that Additional Finance Charges is an enabling penal provision in the agreement entered into between the parties. It is the additional burden on the borrower who is not prompt in repaying the borrowed money and the interest thereon in the form of Equated Monthly Instalments. AFC is only a mechanism to ensure recovery of the amount lent by the assessee. He further submitted that when a normal EMI itself has not been .....

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sed. He further submitted that AFC does not partake the character of income and there is no bar in the Income Tax Act that the profit and loss account and balance sheet prepared under the Companies Act will have to be followed for the purpose of Income Tax Act for computation of income. 15. In support of his contention, he relied on the decision of this Court reported in [2005] 275 ITR 451 (CIT V. Annamalai Finance), to submit that when the instalment itself is overdue and is not collected, it i .....

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me Tax Act, which is necessary for the disposal of the case reads as follows: Post amendment: Method of accounting. 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 subsection (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 .....

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he Assessing Officer, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Assessing Officer may determine : Provided further that where no method of accounting is regularly employed by the assessee, any income by way of interest on securities shall be chargeable to tax as the income of the previous year in which such interest is due to the assessee : Provided also that nothing contained in this subsection shall preclude an .....

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n from the records that the assessee, which is a nonbanking financial company entered into a lease agreement with its customers. One of the clauses in the agreement provides for if the monthly instalments (EMI) have not been paid, it would carry additional finance charges (AFC) in the prescribed rate. The assessee maintain its accounts with respect to the AFC charges under cash/receipt system for the purpose of Income Tax. In the event of default in payment of instalments due on the due dates, t .....

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w. 19. In an identical circumstance, this Court had an occasion to consider the issue in respect of overdue charges, in the case of Commissioner of Income Tax V. M/s.Annamalai Finance Ltd. reported in [2005] 275 ITR 451 While dealing with the issue whether on the facts and in the circumstances of the case, the Tribunal was right in upholding the action of the assessee in changing the method of accounting of overdue interest alone on a cash basis, when the system of accounting of the assessee was .....

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of hire-purchase and lease agreements. As per the terms of the agreements, overdue charges are payable by the parties concerned to the assessee when they make defaults in paying the instalments as per the schedule of payments. When the instalment itself is overdue, is not collected, there is no basis for making out a case that the additional overdue charges payable by the parties would be collectible with certainty. The terms of the agreements which enable the assesseecompany to demand overdue c .....

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n the above-said decision was that during the assessment years in question, the Assessing Officer during the course of reassessment found that the assessee had changed the method of accounting from mercantile system to cash system for overdue charges alone and held that the same is not permissible. Accordingly, the Assessing Officer added the overdue charges to the income of the assessee, which was upheld by the first Appellate Authority. On appeal by the assessee, the Tribunal reversed the same .....

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Calcutta High Court reported in (2003) 263 ITR 129 (Hela Holdings Pvt. Ltd. v. CIT) wherein, the Calcutta High Court had laid down certain general principles regarding tax avoidance and tax evasion, held that the Revenue was not in a position to demonstrate or satisfy that due to the change of accounting method adopted by the respondent/assessee, which is permissible in law, the Revenue suffered any loss. 22. It is pertinent to note that the provisions of Section 145 of the Income Tax Act, namel .....

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the legal issue has been resolved in facts identical to the present case. 23. We find that what has been decided by this Court in the earlier decision is the manner in which the AFC charges should be treated for the purpose of income tax. We have extracted in the earlier portion of this order that it has been held that in respect of AFC, there is an element of uncertainty and therefore, it has to be treated as income only on receipt. There is no departure on the part of the assessee from the me .....

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aid view, which has also been accepted by the Department. The real income theory propounded by the Department would be applicable only if there is a justification to come to the conclusion that AFC has become income in the hands of the assessee. When it has already been held otherwise in the above-said decision and the Department having accepted such a principle, we find no reason to depart from that view in the present case. 25. The reliance placed by the learned Standing Counsel appearing for .....

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eld as follows: Theory of Real Income An interesting argument was advanced before us to say that a provision for NPA, under commercial accounting, is not an income hence the same cannot be added back as is sought to be done by the Department. In this connection, reliance was placed on Real Income Theory . We find no merit in the above contention. In the case of Poona Electric Supply Co. Ltd. v. Commissioner of Income-Tax, Bombay City I, 57 ITR 521 at page 530, this is what the Supreme Court had .....

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Wealth-Tax, Bombay v. Bombay Suburban Electric Supply Ltd. 103 ITR 384 at page 391, where it was observed as under: Income Tax is a tax on the real income, i.e., profits arrived at on commercial principles subject to the provisions of the Income Tax Act, 1961. The real profits can be ascertained only by making the permissible deductions . The point to be noted is that the IT Act is a tax on real income , i.e., the profits arrived at on commercial principles subject to the provisions of the IT Ac .....

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ack to that extent in the computation of total income under the IT Act. 25.2. A plain reading of the above-said decision reveals that it is a case of bad debts. The facts in the above decision is that the assessee had made provision for NPA for the financial year ending 31.3.1998 under the directions of the RBI and claimed deduction. Accordingly, the profit and loss account was debited and corresponding amount was shown in the balance-sheet. The Assessing Officer disallowed the same and add back .....

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be written off as per the provisions of the Income Tax Act and not by the application of real income theory. 25.3. The facts in the present case are distinguishable. Here, the assessee has not recognised the AFC as income for the purpose of Income Tax Act until it is received. But for the purpose of companies Act, the assessee has accounted it. The provisions of the Companies Act require it to be so. Section 145 of the Income Tax Act provides that the income has to be computed either under cash .....

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inty and on actual receipt becomes income. 25.4. In the decision reported in [2010] 321 ITR 546 (Commissioner of Income Tax & Anr. v. United Breweries Ltd.), the High Court of Karnakata while dealing with the bad debts held that the deduction of bad debts was not regulated by real income theory. The facts in the said decision was the assessee in the course of activity of manufacture and sale of beer furnished guarantee for repayment of certain loans and advances taken by its subsidiary compa .....

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uded on the principle of real income. The High Court answered the issue in favour of the Revenue. 25.5. In the present case, there is no claim of deduction of bad debts. The claim of AFC, which is in penal nature, is uncertain of recovery and hence, the same is not recognized as income accrued till it is realized. 25.6. In the decision reported in (2012) 210 Taxman 62 (Madras) (The United Nilagiri Tea Estates Co. v. Deputy Commissioner of Income Tax), this Court dealt with the issue whether inte .....

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ceived certain amount. The Assessing Officer assessed the income holding that since the assessee had not written off the principal amount as well as interest on accrual basis. This was set aside by the Commissioner of Income Tax (Appeals). On appeal, the Tribunal reversed the same. On further appeal, this Court also held that the concept of real income would be applicable irrespective of whether the accounts are maintained in cash system or in the mercantile system. If the accounts are maintaine .....

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mprobability or realisation of interest income or for that matter, even the principal. This Court held that under the mercantile system of accounting, accrual had occurred and therefore it has to be treated as income. 25.9. In the above-said decision, in the absence of any material to suggest as to the improbability or impossibility of the realisation of the amount even for accrual, this Court confirmed the order passed by the Tribunal. 26. In the present case, the AFC is in penal nature. This C .....

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ance (supra) on the theory of actual receipt of AFC as income stands fortified. 27. In the light of the above, we hold that the decisions relied on by the learned Standing Counsel appearing for the Revenue are distinguishable on facts. 28. It is to be noted that in the instant case, the Revenue is not in a position to show that due to the change of accounting method, the Revenue suffered loss. Admittedly, there is no finding to that effect in the assessment order. We also find that the change in .....

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y this Court in another decision in respect of the same assessee for the assessment year 1997-98 reported in [2009] 319 ITR 196 (Mad.), which is a post-amendment to Section 145 of the Act and held in favour of the assessee. Therefore, there is no distinction insofar as the present case is concerned. 30. The facts in the above-said decision, as narrated in the above -decision are as follows: 2. The facts, as culled out from the memorandum of grounds, are as follows: During the previous year ended .....

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-98, in the case of Companies, the method of accounting is to be followed strictly the mercantile system of accounting i.e. on accrual basis including that of overdue charges of hire purchase and lease for standard and non-standard assets. The assessee-Company filed the details and it is found that the overdue charges on accrual basis in respect of hire charges and lease in respect of the amount of ₹ 82,23,892/- and ₹ 24,37,922/- respectively aggregating to an amount of ₹ 1,06, .....

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wn that when undertainties exist regarding determination of the amount or its collectability, the revenue shall not be treated as accrued and hence shall not be recognised until collection. 5. The recognition of revenue on accrual basis presupposes the satisfaction of two conditions viz. The revenue is measurable and that the revenue is collectable without any uncertainty. Taking into account these standards also, the assessee submitted that the overdue on financial charges on hire purchase and .....

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