Calcutta H.C : Interest on non-operational sticky loans shown in suspense account is not taxable on accrual basis, rather such an interest would be accounted for as and when it is realized

High Court Of Calcutta

UCO Bank VS. CIT, West Bengal -Iii, Kolkata

Assessment Years : 1975-76 To 1986-87

Section : 4, 5, 6

Indira Banerjee And Anindita Roy Saraswati, Jj.

It Appeal No. 43 Of 2002

December 2, 2013

JUDGMENT

Indira Banerjee, J. – This appeal under Section 21 of the Interest Act 1974 read with Section 260 A of the Income Tax Act 1961 has been filed by the Assessee bank in relation to the Assessment Years 1975-1976 to 1986-1987 except for the Assessment Year 1980-1981.

2. The issue involved in this appeal is, whether interest on sticky loans, not credited by the Assessee Bank in its Profit and Loss Account, by reason of recovery being extremely doubtful, is liable to tax under the Interest Act 1974.

3. The assessee bank follows a mixed system of accounting, which is mainly mercantile, but in respect of certain sticky loans, that is, loans of which recovery is doubtful, on realization basis. The interest on sticky loans is not credited to the Profit and loss Account. Such interest on sticky loans were transferred to the Suspense Account upto 31st December 1980. After 1981 interest on the sticky loans was not at all entered in the Books of Accounts. A memorandum was maintained of possible interest. As and when interest on such sticky loans was actually realized, tax thereon was paid under the Interest Act as well as the IT Act.

Sections 4, 5 and 6 of the Interest Act provide as follows:—

“4. Charge of tax— (1) Subject to the provisions of this Act, there shall be charged on every scheduled bank for every assessment year commencing on or after the first day of April, 1975, a tax (in this act referred to as interest-tax) in respect of its chargeable interest of the previous year at the rate of seven per cent. of such chargeable interest:

Provided that the rate at which interest tax shall be charged in respect of any chargeable interest accruing or arising after the 31st day of March, 1983, shall be three and a half per cent. of such chargeable interest.

(2) Notwithstanding anything contained in subsection (1) but subject to the other provisions of this Act, there shall be charged on every credit institution for every assessment year commencing on and from the first day of April, 1992, interest-tax in respect of its chargeable interest of the previous year at the rate of three per cent. of such chargeable interest.

Provided that the rate at which interest-tax shall be charged in respect of any chargeable interest accruing or arising after the 31st day of March, 1997, shall be two per cent. of such chargeable interest.

5. Scope of chargeable interest — Subject to the provisions of this Act, the chargeable interest of any previous year of a credit institution shall be the total amount of interest (other than interest on loans and advances made to other credit institutions [or to any co-operative Society engaged in carrying on the business of banking]) accruing or arising to the credit institution in that previous year:

Provided that any interest in relation to categories of bad or doubtful debts referred to in section 43D of the Income Tax Act shall be deemed to accrue or arise to the credit institution in the previous year in which it is credited by the credit institution to its profit and loss account for that year or, as the case may be, in which it is actually received by the credit institution, whichever is earlier.

6. Computation of chargeable interest — (1) Subject to the provisions of sub-section (2), in computing the chargeable interest of a previous year, there shall be allowed from the total amount of interest (other than interest on loans and advances made to credit institutions) accruing or arising to the assessee in the previous year, a deduction in respect of the amount of interest which is established to have become a bad debt during the previous year:

Provided that such interest has been taken into account in computing the chargeable interest of the assessee of an earlier previous year and the amount has been written off as irrecoverable in the accounts of the assessee for the previous year during which it is established to have become a bad debt.

Explanation — For the removal of doubts, it is hereby declared that in computing the chargeable interest of a previous year, no deduction other than the deduction specified in this sub-section shall be allowed from the total amount of interest accruing or arising to the assessee.

(2) In computing the chargeable interest of the previous year, the amount of interest which accrues or arises to the assessee before the first day of August, 1974, or during the period commencing on the first day of March, 1978, and ending with the 30th day of June, 1980 or during the period commencing on the first day of April, 1985 and ending with the 30 day of September, 1991, shall not be taken into account.

4. In case of assessment of tax under the Income Tax Act, no tax was levied on sticky loans on accrual basis. This was clarified by a circular of the Board dated 6th October 1952, which was rescinded in view of the judgment of the Kerala High Court in the case of State Bank of Travancore v. CIT [1977] 110 ITR 336, inter alia holding that tax on interest was payable on accrual basis. The judgment of the Kerala High Court was affirmed by the Supreme Court in State Bank of Travancore v. CIT [1986] 158 ITR 102/24 Taxman 337 (SC).

5. In the meanwhile, by another circular dated 9th October 1984 the old position was restored. The said circular made it clear that the circular dated 6th October 1952 would apply till the Assessment Year 1978-1979 and the Circular dated 9th October 1984 would apply from the Assessment Year 1979-1980.

6. The minority view of Tulzapurkar J in State Bank of Travancore (Supra)that, interest payable on sticky loans constituted hypothetical income and if the assessee could, to the satisfaction of the taxing authorities establish that the advance and/or loan had become sticky, the interest payable could not be taxed, irrespective of the method of accounting followed by the assessee, was affirmed by the Supreme Court in UCO Bank Ltd. v. CIT [1999] 237 ITR 889/104 Taxman 547.

7. In UCO BankLtd. (supra)the Supreme Court considered the question of whether interest on a loan, which had not been recovered by the assessee bank for several years, recovery of which was doubtful, and therefore not included in the profit and loss account of the assessee bank, but had been kept in a suspense account, could be included in the income of the assessee bank in the assessment year in question.

8. Observing that interest on loans, recovery of which had become doubtful, had not been brought to the profit and loss account of the assessee bank, but kept in a suspense account, the Supreme Court held that such loan interest did not form part of the real income of the assessee bank, even though the assessee bank was found to follow the mercantile system of accounting.

9. The Supreme Court found that the assessee bank had been following a mixed system of accounting and in effect and substance, approved such mixed system of accounting. The Supreme Court held:—

“The question whether interest earned on what have come to be known as ‘sticky loans’ can be considered as income or not until actual realisation, is a question which may arise before several Income Tax Officers exercising jurisdiction in different parts of the country. Under the accounting practice, interest which is transferred to the suspense account and not brought to the profit and loss account of the company is not treated as income. The question whether in a given case such ‘accrual’ of interest is doubtful or not, may be problematic. If, therefore, the Board has considered it necessary to lay down a general test for deciding what is a doubtful debt, and directed all Income Tax Officers should treat such amounts as not forming part of the income of the assessee untained realised, the direction by way of the circular cannot be considered as travelling beyond the powers of the board under section 119 of the Income Tax Act. The circular of October 9, 1984, therefore, provided said test for recognising whether a claim for interest can be treated as a doubtful claim unlikely to be recovered or not. The test provided by the said circular is to see whether at the end of 3 years, the amount of interest has, in fact, been recovered by the bank or not. If it is not recovered for a period of 3 years, then in the 40 year and on the words the claim for interest has to be treated as a doubtful claim which need not be included in the income of the assessee until it is actually recovered.”

The Supreme Court further held:

“in the premises the majority decision in the State Bank of Travancore v. CIT [1986] 158 ITR 102 (SC) cannot be looked upon as laying down that the circular which is properly issued under section 119 Of the Income Tax Act for proper administration of the Act and for relieving the rigour of too literal construction of the law for the benefit of the assessee in certain situations would not be binding on the departmental authorities. This would be contrary to the ratio laid down by the bench of 5 judges of the Supreme Court in Navnit Lal (C) Javeri………it is held only as laying down that a circular cannot alter the provisions of the Act……..The circular, therefore, cannot be treated as contrary to section 145 of the Income Tax Act or Illegal in any form. It is meant for a uniform administration of law by all the income tax authorities in a specific situation and, therefore, validly issued under section 119 Of the Income Tax Act. As such, the circular would be binding on the Department.”

10. As held by the Supreme Court in UCO Bank Ltd (supra), under Section 145 of the Income Tax Act, income chargeable under the head ‘profit and gains of business or profession’ or ‘income from other sources’ shall be computed in accordance with the method of accounting regularly employed by the assessee, provided that in a case where the accounts are correct and complete, but the method employed is such that, in the opinion of the Income Tax Officer, the income cannot properly be deduced therefrom, the computation shall be made in such manner and on such basis as the income tax officer may determine. In the case of the assessee bank, the method employed by the assessee bank of following the mercantile system, but treating interest on sticky loans in a suspense account was approved. The judgement of the Supreme Court in UCO Bank Ltd. ( supra)was affirmed and followed by the Supreme Court in Mercantile Bank Ltd. v. CIT [2006] 283 ITR 84/153 Taxman 97 (SC).

11. In view of the judgements of the Supreme Court in UCO Bank Ltd. ( Supra)and in Mercantile Bank Ltd. (Supra), it is well settled that interest on ‘Sticky Loans’, recovery whereof is doubtful, if not shown in ‘Profit and Loss Account’ should be treated as not forming part of the income of the assessee, irrespective of whether the assessee otherwise follows the mercantile system of accounting. The question in this appeal is whether the principle applicable in the case of computation of income under the Income Tax Act would apply in relation to computation of chargeable interest under the Interest Act.

12. By an order dated 20th August 2002, this Court admitted the appeal on the following questions of law:

‘1. Whether in the facts and circumstances of this case, there being in the assessee’s accounts certain “sticky” loans which are non-operational and in respect of which the mercantile accrual of interest was shown only in the suspense account upto 31. 12. 1980, and thereafter only the memorandum kept in respect of it, and not in the profit and loss account, tax under the Interest Tax Act, 1974 is payable?

2. Whether in the above facts and circumstances of the case, it being already a matter decided for the assessee, that no income tax is payable on the above mercantile accrual of interest, shown in the suspense account or by way of memorandum, for the relevant assessment years in question, on non-operational i.e. “sticky” loans, interest under the said Interest Tax Act can nonetheless be payable in law?

3. Whether for the relevant assessment years in question, tax under the Interest Tax Act, 1974 for the above non-operational loans, is to be held as payable in law on the mercantile accrual of interest basis, or on the basis of actual receipt of interest income on the sticky loans, if such interest at all was received in the relevant assessment years?’

13. Chargeable interest has been defined in Section 2 (5) of the Interest Act 1974, to mean the total amount of interest referred to in Section 5, computed in the manner laid down in Section 6. Thus, chargeable interest of any previous year of a credit institution is the total amount of interest (other than interest on loans and advances made to other credit institutions, co-operative societies etc., accruing or arising to the credit institution in that previous year.

14. Chargeable interest is interest that accrued or arose in the previous year, irrespective of whether such interest was actually received. Thus, where any loan or advance is given for a certain term, for example, where a loan is given for 5 years and interest is to be computed periodically, but is actually realised in advance, at the time of disbursement of the loan/advance, the interest would become chargeable periodically and not at the time when it is actually realised. Similarly, if the interest is to be computed in monthly, quarterly or yearly rests, chargeable interest would accrue at the end of the month, quarter or year, as the case may be, even though actual realisation may take place at a later date.

15. In our view, interest on loans and advances, of which recovery has become extremely doubtful, and which is written off for all practical purposes, but recorded separately, in the faint hope of recovery at some future point of time, may be, by initiation of litigation, does not come within the purview of chargeable interest within the meaning of Sections 5 and 6 of the Interest Act.

16. Moreover, the proviso to Section 5 of the Interest Act specifically provides that interest in relation to categories of bad or doubtful debts, referred to in Section 43D of the Income Tax Act, shall be deemed to accrue or arise in the previous year in which it is credited to the profit and loss account for that year. If the interest, recovery of which is doubtful, is not credited in the profit and loss account of the previous year, the interest would not fall within the scope and ambit of chargeable interest under the Interest Act.

17. For the reasons discussed above, Question I and 2 are answered in the negative, in favour of the assessee and against the Revenue.

18. We have already held that non-operational sticky loans in respect of which mercantile actual of interest was shown in the suspense account and not the profit and loss account, would not, in law, be payable on mercantile accrual basis. Interest on such loans would have to be accounted for and paid as and when it is realised. Question number 3 is answered accordingly and in favour of the assessee.

19. The appeal filed by the assessee is, thus, allowed.

20. Let photostat certified copy of this judgment and/or order, if applied for, be supplied to the learned advocates appearing for the parties expeditiously subject to compliance of requisite formalities.

[Citation : 360 ITR 567]