Karnataka H.C : Where assessee, engaged in providing long-term finance, received certain amount as processing fee and penal interest for repayment of loan before agreed period, those charges being incidental to earning of interest income, were to be included in income eligible for deduction under section 36(1)(viii)

High Court Of Karnataka

CIT Vs. Weizmann Homes Ltd.

Assessment Years: 1998-99, 2000-01 And 2001-02

Section : 36(1)(viii), 115JA

Kumar And B. Manohar, Jj.

It Appeal Nos. 918 Of 2006 And 341 & 343 Of 2007

March  4, 2013

JUDGMENT

N Kumar, J. – All these appeals are taken up for consideration together, because the assessee is the same, but the assessment years are different, where one question of law is common in three cases and yet another question of law is common to the subsequent two years.

2. The assessee – M/s. Weizmann Homes Ltd, is a company carrying on the business of long term finance. The assessee claimed Rs.48,26,000/- as deduction under section 36(1)(viii) of the Income-tax Act, 1961 being the amount transferred to special reserve. The assessee has taken long term income of Rs.176.75 lakh. The assessee included fee, penal interest and other charges of Rs.30.63 lakh in the long term income. The assessee was called upon to explain why the miscellaneous receipts like fee, penal interest and other charges should be included as income from long term housing finance. The assessee replied by saying that the company has included the penal interest and pre-closure charges, for special reserve calculation which are collected from the housing loan borrowers who have availed housing loan for periods of 5 years and above. The penal interest is levied for delayed payment of interest and/or monthly instalments and the pre-closure charges are levied for early closure of the loan as per the norms of the company. Hence, these incomes are in the nature of long term only and the company does not lend individual housing loans for a period of less than five years.

3. The Assessing Authority did not accept the said explanation. As per section 36(1)(viii) of the Act, 40% of the profit derived from providing long term finance only is eligible for deduction. Profits derived from the loan, the terms of which stipulate repayment within a period of more than 5 years only are eligible for deduction. The income in respect of loans closed before 5 years does not come under income from long term finance. Processing fee is derived from the normal business activity, which is independent of terms and conditions of loan, quantum of the loan etc. It is just income received from formal procedure of clearing loan document. It cannot be held to be the income for long term finance. It is not related to actual loan asset per se, but it is reimbursement of handling expenses and it is not related to long term finance. Therefore, the Assessing Authority held that income from fees, penal interest, pre-closure charges etc. are not part of the profits derived from the business of long term income. Therefore, he proceeded to recompute the income after excluding Rs.30 lakh of fees and other charges from long term finance income. Aggrieved by the said order, the assessee preferred an appeal to the Commissioner of Income-Tax (Appeals), Bangalore.

4. The Appellate Authority agreed with the contentions of the assessee that the processing fee, penal charges and other miscellaneous charges are directly attributable to and derived from the business of long term finance. Therefore, the Assessing Officer was directed to consider the processing fee, penal charges and miscellaneous income as part of eligible profit under section 36(1)(viii) of the Act. Aggrieved by the said order, the Revenue preferred an appeal before the Tribunal. The Tribunal held that the processing fee, penal interest and other charges are incidental to earning of interest on long term finance. So far as processing fee is concerned, there is a direct nexus with the business of the assessee for the purpose of long term finance. Regarding pre-closure charges etc., are also directly linked with the interest earned by the assessee out of long term finance. Penal interest charges by the assessee is nothing but late payment of interest, which is earned by the assessee as provided in the contract with the party. Therefore, the Tribunal upheld the order of the Appellate Authority and dismissed the appeal. Aggrieved by the said order, the Revenue is in appeal.

5. In the assessment order of the subsequent years, the assessee had added back the provision for contingencies at Rs.12,30,220.00 and lease equalization reserve at Rs.33,08,176. But while computing the income under section 115JA of the Act, the assessee failed to do so. The lease equalization reserve reduced from lease rental is only a reserve for doubtful income. The Assessing Authority found this provision for contingencies is an unascertained liability. The same is added back while computing the regular income but only to reduce the liability for MAT income the assessee failed to give the uniform treatment. Therefore, he removed the said defect by adding the said incomes for the computation of MAT income. Aggrieved by the said order, the assessee preferred an appeal. The Appellate Authority following the judgments of the Supreme Court, Mumbai and Delhi Tribunals deleted the addition of lease equalization reserve and provision of contingency to the book profit under Section 115JA(2) and 115JB(2) for assessment years 2000-01 and 2001-2002 respectively. Aggrieved by the said order, the Revenue preferred an appeal to the Tribunal. The Tribunal did not find any infirmity with the said order and therefore dismissed the appeal. Aggrieved by the said order, the Revenue is in appeal. Therefore two substantial questions of law which arise our consideration in these appeals are as under:

1. Whether the Tribunal is right in holding that the miscellaneous income of Rs.30,63,000/- derived from penal charges, processing fee and other income can also be treated as eligible profit for the purpose of deduction under section 36(1)(viii) of the Act when deriving income from providing long term finance being the eligible business?

2. Whether the provision for doubtful debts/advance made by the assessee cannot be added back to the book profit of the company as per Explanation to section 115JA of the Act for the purpose of computing the incomes under Section 115JA of the Act?

6. Section 36(1)(viii) of the Act is substituted by Finance Act, 2000, which came into effect from 1 4.2000. However, we are concerned with period anterior to the said period. Therefore, the questions of law raised have to be answered in the context of the provision which was in force on the day the assessment order came to be passed. The relevant provision, which was in force as on that day, is as under:

“36(1)(viii)(e) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28.

(viii) [In respect of any special reserve created [and maintained] by a financial corporation which is engaged in providing long-term finance for [industrial or agricultural development or development of infrastructure facility in India or by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes, an amount not exceeding forty per cent of the profits derived from such business of providing long-tern, finance (computed under the head “Profits and gains of business or profession” [before making any deduction under this clause] carried to such reserve account:]

[Provided that the corporation [or, as the case may be, the company] is for the time being approved by the Central Government for the purposes of this clause;]

Provided [further] that where the aggregate of the amounts carried to such reserve account from time to time exceeds [twice the amount of] the paid-up share capital [and of the general reserves] of the corporation [or, as the case may be, the company], no allowance under this clause shall be made in respect of such excess.

[Explanation.- In this clause,

(a), (b), (c) and (d)** ** **

[(e) “long-term finance” means any loan or advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereof during a period of not less than five years:]”

7. Section 36 of the Act deals with other deductions, which are not specifically provided under the Act. It deals with profit derived from long term finance. Long term finance has been defined to be any loan or advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereof during a period of not less than five years. Once this condition is fulfilled then the main provision provides an amount not exceeding 40% profit derived from such business of providing long term finance is already to such reserve account. In other words, that amount is not taxable. How the profits from the said long term finance is to be computed is also made clear. The said profit is to be computed under the head profits and gains of business or profession before making any deduction under this Clause.

In the instant case, it is not in dispute that the assessee is in the business of long term finance. As it is clear from the agreement, the amount loaned has to be repaid within a period of 7 years. Now the amounts, which are claimed as derived from the business, are (1) processing charges, (2) foreclosure charges and (3) penalty or late payment charges. The reason for denying the said benefit is that though the loan is advanced and repayable within 7 years, the loan has been repaid with interest before expiry of 5 years period. Therefore, Section 36(1)(viii) is not attracted. Secondly, it is contended that processing charges are collected in the course of normal business. It has nothing to do with the long term finance business and therefore the amount derived under the said head is not entitled to be included under the heading of profit derived from long term finance business.

8. Learned counsel appearing for the Revenue contends that the word ‘derived from’ has to be construed narrowly. In support of his contentions, he relies on the judgment rendered in the case of Pandian Chemicals Ltd. v. CIT [2003] 262 ITR 278/129 Taxman 539 (SC), where a reference is made to the judgment of the Privy Council in CIT v. Raja Bahadur Kamakhya Narayan Singh [1948] 16 ITR 325 (PC) and also the judgment of the Apex Court in Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84 (SC) and the constitution Bench in the case of Mrs. Bacha F Guzdar v. CIT [1955] 27 ITR 1 (SC) where it is held that the word ‘derived from’ in section 80HH of the Act must be understood as something which has a direct or immediate nexus with the appellant industrial undertaking. Reliance is also placed on the judgment of Apex Court in the case of CIT v. Staling Foods [1999] 237 ITR 579, where the earlier view of the Supreme Court was reiterated by saying that there must be, for the application of the words ‘derived from’, a direct nexus between the profits and gains and the industrial undertaking. Further reliance is placed on the judgment of the Delhi High Court, where the same view is reiterated in the case of National Co-operative Development Corpn. v. Asstt. CIT [2011] 16 taxmann.com 251/[2012] 204 Taxman 6 (Delhi). The Apex Court in the case of Liberty India v. CIT [2009] 317 ITR 218/183 Taxman 349 (SC), held at page 11 at para 14 that the words ‘derived from’ is narrower in connotation as compared to the words ‘attributable to’. In other words, by using the expression ‘derived from’, Parliament intended to cover sources not beyond the first degree. There cannot be any quarrel with the said propositions.

9. In the instant case, the assessee is in the business of long term finance. In order to carry on the said business, a debtor, who needs the assistance, has to make an application in writing. To consider the said application before granting loan, the assessee collects processing charges. After the debtor is found to be eligible to grant loan, agreements are entered into and thereafter loan is advanced. The amount has to be repaid with interest within 7 years period for repayment of the loan. The agreement also contains the stipulation that the amounts are not paid periodically as agreed to, the debtor has to pay penal interest. If the debtor chooses to repay the amount and foreclose before the agreed period, then not only he has to pay the loan amount plus interest, he has also to pay additional interest, as he is not entitled to the benefit in respect of lower rate of interest, which was spread over the period of 7 years. All these amounts, which are paid by the debtor to the assessee, have a direct nexus with the business, which he is carrying on. All these incomes are derived from the business, which he is carrying on. It is also on record except this long term finance business, the assessee is not carrying on any other business much less any short term finance business. Therefore, all these categories of incomes which the assessee is receiving as a direct nexus with the long term finance and therefore section 36(1)(viii) of the Act is attracted. Therefore, we do not see any merit in these appeals. Accordingly, the first substantial question of law is answered in favour of assessee and against the Revenue.

10. Section 115JA of the Act reads as under:

“Deemed income relating to certain companies.

(1) Notwithstanding anything contained in any other provisions of this as computed under this Act, where in the case of an assessee, being a company, the total income, as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 1997 [but before the 1st day of April, 2001] (hereinafter in this section referred to as the relevant previous year) is less than thirty per cent of its book profit the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to thirty per cent of such book profit.

(2) Every assessee, being a company, shall, for the purposes of this section prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956(1 of 1956):

Provided that while preparing profit and loss account, the depreciation shall be calculated on the same method and rates which have been adopted for calculating the depreciation for the purpose of preparing the profit and loss account laid before the company at its annual general meeting in accordance with the provisions of section 210 of the Companies Act, 1956 (1 of 1956):

Provided further that where a company has adopted or adopts the financial year under the Companies Act, 1956 (1 of 1956) which is different from the previous year under the Act, the method and rates for calculation of depreciation shall correspond to the method and rates which have been adopted for calculating the depreciation for such financial year or part of such financial year falling within the relevant previous year.

Explanation. – For the purposes of this section, “book profit” means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by-

(a) the amount of income-tax paid or payable, and the provision therefor; or

(b) the amounts carried to any reserves by whatever name called; or

(c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or

(d) the amount by way of provision for losses of subsidiary companies; or

(e) the amount or amounts of dividends paid or proposed; or

(f) the amount or amounts of expenditure relatable to any income to which any of the provisions of Chapter III applies;

[(g) the amount or amounts set aside as provision for diminution in the value of any asset,”

11. This provision applies to only companies. If the total income of the company has computed under the provisions of this Act is less than 30% of book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to 30% of such book profit. Explanation to the section states for the purposes of this section, ‘book profit’ means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2) as increased by the amount mentioned in the explanation. One such amount which we are concerned is in sub-clause (c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities. By Finance Act No.2 of 2009 w.e.f. 1.4.1998, the present Clause (g) has been substituted by including the amount or amounts set aside as provision for diminution in the value of any asset. The said provision is applied to the facts of this case. In the instant case, Rs.12,30,220/- has been set apart to meet the contingencies. The said amount has not been included in the book profit. It was unascertained liability. Even this amount is earmarked as provision for diminution in the value of any asset for the purpose of arriving at the book profit for the purpose of Section 115JA which ought to have been included. The Assessing Authority was justified in adding the said amount to the book profit. Both the Appellate Authorities committed a serious error in deleting the said amount. It is contrary to the statutory provision. That portion of the order of Tribunal requires to be set aside and accordingly it is hereby set aside and the substantial question of law is answered in favour of Revenue and against the assessee.

In the light of what is stated above, ITA No.918/2006 is dismissed. ITA Nos.341 and 343 of 2007 are allowed only insofar as computation of income under section 115JA of the Act is concerned. The Assessing Authority shall bring the assessment inconformity with this order.

Sri S Parthasarathi, learned Advocate is permitted to file vakalathnama in ITA No.918/2006 on behalf of respondent within four weeks.

[Citation : 357 ITR 74]