TMI Blog2002 (12) TMI 56X X X X Extracts X X X X X X X X Extracts X X X X ..... ollowing the cash system of accounting for interest receivable on sticky loans and the mercantile system of accounting for other receipts ? (2) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in holding that the interest on 'sticky loans' should be assessed on cash basis and not on accrual basis ? (3) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in holding that penal interest paid to the Reserve Bank of India is not disallowable ?" On a perusal of the statement of case as provided by the Tribunal it appeared that the Revenue had initially sought for referring as many as six questions for the opinion of this court. However, the Tribunal finding that two of the questions being academic in nature, inasmuch as similar questions had been answered by this court earlier did not deem it fit to refer the same. In respect of the other four questions the Tribunal has thought it fit to refer as is now referred for our opinion. The facts as emerge from the statement of facts by the Tribunal is that the respondent-assessee a nationalised bank carrying on the business o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der consideration is the subject matter of the first two questions referred for our opinion. It appears that the Assessing Officer had disallowed the claim of the assessee that it is not assessable in the assessment year in question and had brought to tax the income in respect of such interest amount also in the assessment year on accrual basis. The assessee having carried the matter further by way of appeal before the Commissioner of Income-tax met with success as the Appellate Commissioner agreed with the stand of the assessee. The Revenue appealed to the Appellate Tribunal, and the appeal having been dismissed by the Tribunal the Revenue had sought for reference of these questions for our opinion. The facts leading to the third question that has been referred for our opinion are that the assessee in the course of its banking activity is governed and regulated by the provisions of the Banking Regulation Act, 1949, and it is imperative that the assessee was required to comply with the provisions of section 24 of this Act in the course of its business activities and for having not complied with the same had been levied with the penal interest under the provisions of section 24(4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the total income of the assessee for the relevant period. It is the submission of learned counsel that the concept of accrual and arisal is what was under consideration and apart from the provisions of section 2(24) read with section 5 of the Income-tax Act the decision of the apex court rendered in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102 makes it very clear that the assessee-bank is liable for payment of tax on this interest attributable to sticky loans also on accrual basis and as such the interest amount should be brought to tax without waiting for the receipt of such income. It is the submission of learned counsel in this regard that the apex court had occasion to consider the concept of real income in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102 and it has been very clearly pointed out by the apex court that the accrual or arisal of the income is not dependent on the volition of the parties or on the conduct of the parties such as making entries in the books of account or in the ledgers indicating the debits and credits to the customer's account and to the bank's interest account, etc., but happens because of the operation of the law, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or not, is not in dispute or not denied by the assessee. In fact accrual or arisal is a stage which is always anterior to the receipt and there is no denial that it is only an income which is accrued that is received at a later point of time. May be in certain situations the accrual and the receipt may be simultaneous but in most of the cases the accrual stage is earlier and the receipt stage is later. It is the further case of the assessee that the assessee had been consistently following this hybrid system of accounting in respect of the interest on sticky loans for the past more than 35 years and that the Department having not only permitted but also having recognised the hybrid system of accounting followed by the assessee whereby the assessee has adopted the cash system, only in respect of interest on sticky loans and the mercantile system of accounting in respect of all other transactions. On this basis, it is the contention of the assessee that there is no reason why the assessee should not be permitted to follow the same system in the accounting year relevant for the assessment year in question. On this aspect the assessee's stand is that the Department having not taken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s on the taxability of the interest on sticky loans had been referred for the opinion of this court in earlier references, viz., in ITRC No. 21 of 1998 (in respect of Canara Bank for the assessment year 1981-82), ITRC Nos. 602 and 603 (in respect of Canara Bank for the assessment year 1986-87) and ITRC No. 929 of 1998 (for the assessment year 1984-85), ITRC No. 298 of 1990-98 (in respect of Vysya Bank for the assessment year 1990-91) and ITRC No. 807 of 1998 and 808 of 1998 (for the assessment year 1987-88 and 1988-89, respectively). The Division Bench of this court had answered all these questions by the earlier decisions on different dates in favour of the assessee and against the Revenue. In this view of the matter, though it would have been proper for us to simply follow the opinion expressed by the earlier Division Bench and dispose of this reference also as learned standing counsel for the Revenue brought to our attention the orders passed in those references and submitted that the Bench having not given adequate reasonings for not following the decision of the apex court which is relied upon in this reference also in support of its case and the earlier Division Bench having ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n and if such conclusion is in any way different or other than the view that has already been expressed then alone further action may be required in this regard and it is for this purpose only we have examined the submissions addressed in the course of this reference though similar references arising out of the common order of the Tribunal have already been answered against the Revenue by this court in the earlier cases. Sri E. R. Indra Kumar, learned senior standing counsel for the Revenue, has cited and placed reliance on the following decisions in support of his submission that the interest income on sticky loans also should be included in the accounting year corresponding to the assessment year in question on accrual basis, the income being real in nature and the assessee having become entitled to receive this income and not having given up its right to receive the same at any time before the income became due to the assessee. The decisions are : (1) E. D. Sassoon and Co. Ltd. v. CIT [1954] 26 ITR 27 (SC) (2) CIT v. A. Gajapathy Naidu [1964] 53 ITR 114 (SC) ; (3) CIT v. Swadeshi Cotton and Flour Mills Private Ltd. [1964] 53 ITR 134 (SC) (4) CIT v. A. Krishnaswami Mud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om) ; (3) CIT v. North Arcot District Co-operative Spinning Mills Ltd. [1984] 148 ITR 406 (Mad) ; (4) CIT v. M. P. Financial Corporation [1997] 227 ITR 888 (MP) ; (5) CIT v. Rajasthan Financial Corporation (No. 1) [1998] 229 ITR 246 (Raj) ; (6) CIT v. Rajasthan Financial Corporation (No. 2) [1998] 229 ITR 252 (Raj) ; and (7) CIT v. Andhra Pradesh Industrial Infrastructure Corporation [1999] 236 ITR 648 (AP). Sri K. P. Kumar has also placed reliance on an unreported decision of the Division Bench of this court rendered in ITRC Nos. 807 and 808 of 1998 dated January 24, 2000, in the case of CIT v. Vysya Bank Ltd. Before we take up discussion on the case law cited and relied upon by learned counsel in support of their respective submissions we think it will be profitable to mention as to what is the real controversy in issue and what issues are required to be addressed by this court to answer the reference. In this regard unfortunately learned counsel have not zeroed in on the real controversy that is required to be resolved as it arises in the context of the facts of the present case but have proceeded to support their respective submissions without so much as address ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the assessee is also given the further option to adopt different methods of accounting in respect of different sources Of income. Under the scheme of the Act it is enjoined upon the authorities in implementing and enforcing the provisions of the Act, to scrupulously follow the provisions of the Act, bring to tax the income of the previous year only in the corresponding assessment year and in no other year subject to the exceptions provided in the Act itself. In the matter of determining as to in which assessment year the income of the assessee is to be subjected to tax not much choice is given either to the Revenue or to the assessee but it is dependent on the application of the provisions of the Act. It is in this back ground that learned counsel for the Revenue is canvassing the submissions that even the interest attributable to the sticky loans having accrued or arisen to the assessee during the previous year relevant to the assessment year in question and such an income being also real in nature and the assessee having not either renounced or given up the right to receive such income before such accrual or arisal and, on the other hand, the assessee having consciously indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ited by him does not further demolish the case of the assessee. In the instant case the assessee is not at all disputing that interest could have accrued or arisen during the previous year relevant for the assessment year in question. There is no controversy either on the real nature of income. The controversy is only with regard to the point of time when such income is to be assessed, This is determined by the method of accounting that is being followed by the assessee in the instant case and when once there is no infirmity or illegality or any contravention of any of the provisions of the Act by the assessee in following the method of accounting which it has been doing then there is no scope for compelling the assessee to offer such income to tax for the accounting period other than the one in which the assessee has to offer the income to tax as per the method of accounting followed by the assessee. In this situation we will briefly refer to the various decisions cited by learned counsel and indicate our conclusions on the same. In E. D. Sassoon's case [1954] 26 ITR 27, the Supreme Court was concerned with the liability of an assessee which had sold away its rights to receive ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that no income accrued or arose in the hands of the transferor company and the question of apportioning the commission does not arise inasmuch as the commission amount to be paid by the principal company itself were being determined only on March 31 of the year when the profits of the principal company were being made up and ascertained and then only the actual amount of commission payable under the principal company and the managing agent was being ascertained for the first time and in such view of the matter no income accrued in the hands of the transferor-company and the transferees also having received the entire commission then only will be liable in respect of such income attributable under the entire commission and were liable to tax. We are afraid that the principle laid down by the Supreme Court in this case and the ratio of the case does not in any way further the case of the Revenue in the instant case. We fail to understand or appreciate the relevance of this decision to the facts of the present case particularly in the context of the question that has been referred for our opinion. CIT v. A. Gajapathy Naidu [1964] 53 ITR 114 (SC) is the next case referred to and rel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt year in question the authorities are bound to bring such income to tax in this assessment year and not in any other subsequent year. Unfortunately, here again the dispute is not as to when the income accrues or arises but when such income is to be brought to tax based on the method of accounting that is being followed by the assessee. Accordingly, we are of the view that this decision also does not further the case of the Revenue on the questions referred for the opinion. In CIT v. Swadeshi Cotton and Flour Mills Private Ltd. [1964] 53 ITR 134, the Supreme Court was concerned with the question as to when actually the liability is incurred by the assessee for claiming the expenditure as a deduction. The assessee was following the mercantile system of accounting and in terms of an award made on January 13, 1949, the assessee was liable to pay a sum of Rs. 1,08,325.9 annas 3 paise, by way of profit bonus to its employees. The assessee debited the amount for the current year 1947 corresponding to the assessment year 1948-49. It was held that the liability for payment of profit bonus was determined only under the award dated January 13, 1949, and it was also in fact paid during ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t disclose the true profits of the assessee and as such while rejecting the profits as declared by the assessee had assessed the income on the basis referred to above. The Supreme Court though found that the High Court had not properly applied itself or appreciated the questions involved in the case in calling for a statement to be made by the Tribunal and for referring the stated questions for its opinion and in answering them in favour of the assessee, nevertheless having regard to the larger issue of interpretation of the scope and meaning of the proviso to section 13 involved in the case proceeded to examine the appeal before it at the instance of the Revenue and concluded that the High Court was in error in holding that the assessee having maintained its accounts in the cash system it was not open to the Income-tax Officer to add to the receipts from the business the value of the stock-in-trade at the end of the year in determining the profits of business for the year in question and accordingly allowed the appeal holding that the Assessing Officer was entitled to ascertain the true profits and income of the assessee under the proviso to section 13 of the Act and as such the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transactions which have been categorised as sticky loans and this method of accounting followed by the assessee having not been either rejected or found fault with by the Revenue and, on the other hand, the Revenue having accepted the returns and computation of income based on such method of accounting for the past over 30 years the case cited by learned counsel for the Revenue does not lend support to the submission canvassed on behalf of the Revenue to include the interest on sticky loans also while computing the profits of the accounting year relevant for the assessment year and ascertaining the income for this year. Existence of power is one thing but exercise of that power in the manner and for the purpose for which it is meant is another thing. The Revenue is not able to demonstrate as to in what manner and for what reasons the Assessing Officer has exercised the power under section 145(1) to reject the returns of the assessee. In the absence of this basic foundation we are afraid that the decision relied upon by learned counsel for the Revenue does not help the Revenue to answer the reference in its favour. The next decision relied upon by learned counsel for the Revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anaged company in view of the heavy losses that the managed company had suffered during the years in question but these resolutions had been passed subsequent to the two general body meetings of the managed company held on November 24, 1955, and July 21, 1956, wherein the annual accounts of the managed company had been passed which included the commission payable to the assessee. The Supreme Court affirming the view taken by the High Court held that the commission amount due to the assessee-company having accrued on December 31, 1954, and December 31, 1955, and actual payment having been deferred till the passing of the annual accounts by the managed company the subsequent relinquishment of this right by resolutions of its board by the assessee-company had not in any way diverted or reduced this income which already accrued to the assessee and as such the assessee was liable to pay tax on the income attributable to such commission also. This was a case where subsequent to the accrual of income the assessee sought to purge itself of the same by its own resolution. This was not approved by the Supreme Court holding that the income which accrues or arises under the provisions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessable to tax only during the accounting year relevant for the assessment year 1962-63. In this regard the court distinguished the decision of the Supreme Court in CIT v. A. Gajapathy Naidu [1964] 53 ITR 114 by approving the reliance placed by the Tribunal on the ratio of the decision of the Supreme Court rendered in E. D. Sassoon and Co. Ltd.'s case [1954] 26 ITR 27 and holding that the law as declared in E. D. Sassoon and Co. Ltd.'s case [1954] 26 ITR 27 (SC) continues to hold the field and was in no way eclipsed by the subsequent decision of the Supreme Court rendered in A. Gajapathy Naidu's case [1964] 53 ITR 114. In this view of the matter, the High Court did not find any reason to interfere with the view taken by the Tribunal and rejected the contention of the Revenue. Sri E. R. Indrakumar, learned counsel appearing for the Revenue placing reliance on this decision of the court submits that if interest income has accrued during the accounting period relevant for the assessment year in view of such legal position it is not open to the Assessing Officer to accept the stand of the assessee that it may be offered as income in the later year and as such cannot be brought to tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot. The liability is not made contingent or dependent on the entries so made by the assessee bank, though in the first instance the Assessing Officer appears to have discussed this aspect to hold that the assessee had contended that the income is not real and no entries had been made by the bank to credit the interest amount to the interest account of the bank. This theory does not appear to have been canvassed by the assessee at all stages. The assessee's stand on the other hand is only on the basis of the method of accounting that it has been following, which had been permitted and which it has followed for the accounting year corresponding to the assessment year in question also. If that is the controversy these decisions do not bear upon the controversy in issue and does not advance the case of the Revenue. Sri Indra Kumar, learned senior counsel, has placed strong reliance on the decision of the Supreme Court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102. In this case, the Supreme Court had occasion to consider as to the concept of "real income" and once the income is "real" and the income which is required to be brought to tax on accrual basis accrues o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccrual 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 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'. The extension of such a value judgment to such a field is pregnant with the possibility of misuse and should be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mere possibility that it may not be possible for the assessee to realise that income does not in any way detract from the approval of the income and as such while the assessee is bound to offer that income to tax, non-realisation could be made a ground for claiming appropriate relief as per the Income-tax Act and on satisfying the conditions prescribed under the Act, the Supreme Court held that the appellant-bank was bound to offer to tax the interest income on accrual/arisal basis though not included in the income. Learned counsel for the Revenue draws our attention to a decision in UCO Bank v. CIT [1999] 237 ITR 889 (SC) and submits that in so far as this decision did not really in any way alter or dilute the law laid down by the Supreme Court in State Bank of Travancore v. CIT [1986] 158 ITR 102 the concept of real income and income being brought to tax on accrual basis, continues to be as enunciated and clarified by the Supreme Court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102. Accordingly, he submitted that in the instant case there is no escape for the assessee from offering the interest on so called sticky loans, in the assessment year corresponding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g issued suitable circulars in this regard to the public financial institutions, there was nothing wrong in the assessee-bank having followed such hybrid system of accounting while offering its income on accrual basis for determination of its income in so far as the income attributable to the interest on sticky loans was being offered on cash system of accounting and as has been permitted by the Department. Sri K. P. Kumar, learned counsel for the assessee, has also drawn our attention to the earlier decisions of this court rendered in ITRC No. 298 of 1998 dated September 30, 1999, ITRC Nos. 602 and 603 of 1998 dated October 1, 1999, ITRC Nos. 807 and 808 of 1998 dated January 24, 2000, and also FFRC No. 21 of 1998 dated December 8, 1999 in this context. Learned counsel for the assessee has also drawn our attention to the provisions of section 145 of the Act which provides for method of accounting that could be followed by the assessee in the context of income chargeable under the head "Profits and gains of business or profession". He submits that the assessee had been permitted to follow the hybrid system of accounting way back in the year 1953 and the Department not only permitte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1) Reform Flour Mills (Pvt.) Ltd. v. CIT [1981] 132 ITR 184 (Cal). This decision was followed in Nawn Estates Pvt. Ltd. v. CIT [1982] 137 ITR 557 (Cal). (2) G. Padmanabha Chettiar and Sons v. CIT [1990] 182 ITR 1 (Mad). But the question before the court is not in the context of what method of accounting can be permitted to be followed by the assessee and as to whether such method of accounting is correct or otherwise. In the instant case, admittedly, the assessee has been allowed to follow such hybrid method of accounting for the last about 20 years or more and the assessee's income offered to tax on the basis of such hybrid method of accounting. Though Sri K. P. Kumar, learned counsel for the assessee, has placed reliance on a few more decisions as indicated and discussed below, namely : (1) CIT v. Industrial Credit and Investment Corporation of India Ltd. [1991] 189 ITR 126 (Bom) ; (2) CIT v. North Arcot District Co-operative Spinning Mills Ltd. [1984] 148 ITR 406 (Mad) ; (3) CIT v. M. P. Financial Corporation [1997] 227 ITR 888 (MP) ; (4) CIT v. Rajasthan Financial Corporation (No. 1) [1998] 229 ITR 246 (Raj) ; and (5) CIT v. Andhra Pradesh Industrial Infrastruc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The Tribunal upheld the view of the Commissioner (Appeals). What emerges is that the Tribunal and the Commissioner (Appeals) had only directed deletion of this income for the assessment year in question on the basis of the method of accounting that had been permitted to be followed by the assessee for the accounting period corresponding to the assessment year as had been done for the past 20 to 25 years. The question as to whether the assessee is correct in following the cash system of accounting for interest receivable on sticky loans and the mercantile system of accounting for other receipts, was not really raised or arose for consideration either before the Commissioner (Appeals) or before the Appellate Tribunal. In fact, this is a question which can arise in the context of permitting an assessee to follow a particular method of accounting as provided under the provisions of section 145 of the Act. This controversy did not arise before the authorities below inasmuch as the Revenue itself had permitted the assessee to follow such hybrid system of accounting and had continued to permit the assessee including in the accounting period corresponding to the assessment year 1987-88. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal in the context of assessing the income of the assessee for the assessment year 1987-88. However, learned counsel for the assessee has brought to our notice that such questions have already been answered in favour of the assessee and against the Revenue in the earlier reference which we have quoted. In this view of the matter, we are constrained to answer questions Nos. 1 and 2 in the affirmative and against the Revenue. This leads us to question No. 3, namely, the correctness of the Tribunal's view in so far as it relates to allowing the penal interest paid by the assessee to the Reserve Bank of India as "liable extent". Elaborate submissions have been made by learned counsel for the Revenue and learned counsel for the assessee on this aspect of the matter also. The assessee being a banking company, is required to observe the statutory conditions and requirements to be followed under the Banking Regulation Act, 1949. Section 24 of this Act compels a banking company to maintain unencumbered approved security of a value of not less than 20 per cent. of the total of its demands and time liabilities at the close of business on any given date. This obligation is on all banking co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erence can be compared to the difference between an "illegality" and "irregularity". If the payment is in the nature of a penalty for violation of a statutory provision, i.e., for an illegal act, the question relating to the amount paid towards such deeds then, penalty being allowed as a deductible item of expenditure does not arise at all, but if it is merely for permitting an 'irregularity" and the payment being in the nature of a compensatory payment for non-compliance with the statutory stipulations partaking of the character of a penal interest and as to whether such payment can be considered as one arising in the course of business and incidental to the business which may perhaps be allowed as an item of deductible expenditure. A deductible expenditure of this nature necessarily should come within the scope of section 37 of the Income-tax Act. Sri Indra Kumar, learned counsel for the Revenue, while drawing attention to section 24 of the Banking Regulation Act, submits that non-compliance with the requirement therein amounts to infraction of the statutory provision and an express penalty has been provided for such an infraction under section 24, sub-sections (4)(a) and (4)(b) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P. Ltd. v. CIT [1993] 201 ITR 684 (SC). The question that arose in the case of E. C. Warnes and Co. Ltd. [1919] 12 TC 227 [KB] was as to whether the sum of 2,000 pounds and litigation costs amounting to 560 and odd pounds was to be permitted as a business loss incidental to the trade the company was carrying on in the context of the Income Tax Act, 1842 as existing in England at the relevant time and in the light of the relevant rules. The assessee-company which was carrying on business in oil and exporting the same had shipped a consignment to Norway. On receipt of information that the said export was in contravention of the provisions of the Customs (War Powers) Act, 1915, and the relevant instructions issued by the Board of Customs and Excise, the Attorney General sued the company for penalty. This action was settled by consent on the agreement of the company to pay a mitigated penalty of 2000 pounds and on such payment, amputations against the company were withdrawn and the company was absolved of its culpability. The assessee-company in fact had incurred 560 and odd pounds of expenditure in defending the proceedings. This amount was sought to be claimed as a loss which the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d been confiscated by the customs authorities in which goods the assessee was carrying on trade. The Supreme Court, affirming the view taken by the Bombay High Court, held that no item of expenditure which was paid by way of penalty for the breach of law that had been incidental to the carrying on of the business and not involving any personal liability, still, cannot be allowed as an amount wholly and exclusively laid out for the business of the assessee within the meaning of section 10(2)(xv) of the Indian Income-tax Act, 1922. The Supreme Court laid emphasis that an amount paid by way of penalty for an infraction of law can never be accepted to be an amount laid out as an item of expenditure for the purpose of carrying on of a lawful business of the assessee. The court also held that it must have been a commercial loss in the normal course of the trade and business and not when the amount paid by way of penalty for a breach of law which may be in the course of carrying on of the trade and business of the assessee. The court also held that infraction of law is not a normal incident of business though it is a matter of normal routine that traders may keep on infracting laws. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any day be less than twenty per cent. of the total of its demand and time liabilities in India. Explanation. -For the purposes of this section 'unencumbered approved securities' of a banking company shall include its approved securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against or availed of ; (2) In computing the amount for the purposes of sub-section (1), the deposit required under sub-section (2) of section 11 to be made with the Reserve Bank by a banking company incorporated outside India and any balances maintained in India by a banking company in current account with the Reserve Bank or the State Bank of India or with any other bank which may be notified in this behalf by the Central Government, including in the case of a scheduled bank the balance required under section 42 of the Reserve Bank of India Act, 1934 (2 of 1934), to be so maintained, shall be deemed to be cash maintained in India ; (2A)(a) Notwithstanding anything contained in sub-section (1) or in sub section (2), after the expiry of two years from the commencement of the Banking Companies (Amendment) Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation in the Official Gazette, vary the percentage referred to in sub-section (2A) in respect of a Regional Rural Bank. (3) For the purpose of ensuring compliance with the provisions of this section, every banking company shall, not later than twenty days after the end of the month to which it relates, furnish to the Reserve Bank in the prescribed form and manner a monthly return showing particulars of its assets maintained in accordance with this section, and its demand and time liabilities in India at the close of business on each alternate Friday during the month, or if any such Friday is a public holiday, at the close of business on the preceding working day; Provided that every Regional Rural Bank shall also furnish a copy of the said returns to the nationalised bank. (4)(a) If on any alternative Friday, or, if such Friday is a public holiday on the preceding working day, the amount maintained by a banking company at the close of business on that day falls below the minimum prescribed by or under clause (a) of sub-section (2A), such banking company shall be liable to pay to the Reserve Bank in respect of that day's default, penal interest for that day at the rate of thre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the court in a suit. (7) When under the provisions of clause (b) of sub-section (4) penal interest at the increased rate of five per cent., above the bank rate has become payable by a banking company, if thereafter the amount required to be maintained on the next succeeding alternate Friday, or if such Friday is a public holiday, the next preceding working day, is still below the prescribed minimum, every director, manager or secretary of the banking company, who is knowingly and wilfully a party to the default shall be punishable with fine which may extent to five hundred rupees and with a further fine which may extend to five hundred rupees for each subsequent alternate Friday or the preceding working day, as the case may be, on which the default continues. (8) Notwithstanding anything contained in this section, if the Reserve Bank is satisfied, on an application in writing by the defaulting banking company, that the banking company had sufficient cause of its failure to comply with the provisions of clause (a) of sub-section (2A), the Reserve Bank may not demand the payment of the penal interest. Explanation.-In this section, the expression 'public holiday' means a day w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action is not in the nature of committing an act which is forbidden in law and if at all, it can, at the best, be characterised as an irregularity and never an illegality. An assessee carrying on such business has only acted in a legally permitted manner. While so carrying on its business, if there are certain technical or statutory infractions, the same cannot be characterised as an illegal activity and as such an item of expenditure incurred cannot be disallowed by applying the principles as have been laid down by the Supreme Court in Prakash Mills' case [1993] 201 ITR 684 and Mahalakshmi Sugar Mills' case [1980] 123 ITR 429 (SC). Learned counsel seeks to make a distinction in the present set of facts and has drawn our attention to the following decisions in support of such submissions. CIT v. Pannalal Narottamdas and Co. [1968] 67 ITR 667 (Bom). In this case, the assessee, an importer, had imported certain items which at the time of clearance was found to be irregular by the customs authorities. The customs authorities confiscated the goods and permitted redemption of the same on payment of fine. The assessee paid the fine and got the goods released. The Bombay High Court took ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovided for in a contract between the parties and can be allowed as an item of deductible expenditure under section 3 and the penal interest in the instant case, which according to learned counsel, is also in the nature of a compensatory payment as has been provided for in the statute itself and as such on the same analogy the amounts paid by the assessee under the provisions of section 24(4)(a) and 24(4)(b) could be allowed as an item of expenditure and urges that the question should be answered against the Revenue and in favour of the plaintiff. Sri K. P. Kumar, learned counsel for the assessee, has also drawn our attention to an earlier decision of the Appellate Tribunal in the case of the very assessee and for the assessment year 1981-82 rendered in I. T. A. 750/Bang of 1985. In this appeal, the Tribunal, following its earlier decision and the view taken in the case of Corporation Bank, held that interest payable by the assessee to the Reserve Bank of India under section 42(3) of the Reserve Bank of India Act, is in the nature of an admissible business expenditure and as such the assessee can claim deduction of the same in computing its business profits. The submission of Sr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uestion which is required to be answered in the context of the provisions of this enactment and having regard to the importance and objectives of this Act. Even assuming that the Tribunal had taken a view one way or the other, unless the view has been affirmed by the High Court on examination in that particular context, the view taken by the Tribunal cannot be said to have attained finality. At any rate, the view taken by the Tribunal in the context of interpretation of the provisions of section 42(3) of the Reserve Bank of India Act and though to some extent these provisions may be analogous to the provisions of section 24(4)(a) and 24(4)(b) of the Act, cannot be a stumbling block in the way of our examining the scope and the nature of the provisions of section 24(4)(a) and 24(4)(b) of the Act. Learned counsel for the assessee has not placed before us any earlier view of our High Court or the Supreme Court in the context of these provisions. Such being the position, the decisions relied upon by learned counsel for the assessee do not come in the way of our examining question No. 3 referred to us for our opinion which we are required to examine and answer. The real point in issu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The provision which provides for levy of penalty, though it is termed "penal interest" under section 24(4)(a) and 24(4)(b) of the Act, is for non-compliance with such requirement stipulated under section 24(2A) of the Act. The requirement of section 24(2A) of the Act is in addition to requirement of section 24(1) which also stipulates a similar compliance. Sub-section (6) of section 24 clearly indicates that the penal interest payable under sub-sections (4) and (5) is a "penalty" and if the penalty amount is not paid it could be enforced as a decree made by a civil court. The Reserve Bank has been given the discretion not to demand payment of penal interest on being satisfied by an application made by the defaulting banking company, i.e., that the banking company had sufficient cause for its non-compliance with the requirements of section 24(2A)(a) as provided for in sub-section (8) of section 24. This is an important provision which throws light that the amount in question is not compensatory in nature, but definitely penal and an opportunity is also provided to the defaulting banking company to satisfactorily explain the non-compliance and to avoid the penalty. Notwithstanding s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as an item of deductible expenditure is that the total taxable income of the assessee gets reduced to this extent with the consequential deduction in the tax liability, which is an incentive for claiming it as an item of deductible expenditure. It will be rather ironic that while under the provisions of the Banking Regulation Act, when the very same Act attracts a penalty it should also be recognised as an act which can also be recognised as a legitimate act under the provisions of the Income-tax Act which Act entails the assessee to claim the expenditure paid by way of penalty, as an item of expenditure incurred for carrying on the business. We do not think that we can permit such an incongruous situation to arise by accepting the submissions made on behalf of the assessee. The activity of banking carried on by the assessee is an activity permitted in law. While carrying on an activity in the nature of business within the limits of law and while so doing if the assessee commits an infraction of the provisions of law it cannot be accepted that the infraction is also part of the carrying on of the business activities of the assessee. The mere possibility that while carrying on i ..... 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