Karnataka H.C : Whether the Tribunal was justified in passing the impugned order with a finding that securities held by the assessee were not in the nature of stock-in-trade and denied the claim of depreciation when the said benefit was extended to the assessee for the earlier years

High Court Of Karnataka

Karnataka Bank Ltd. vs. ACIT, Circle 2(1)

Assessment Year : 2004-05

Section : 32

Kumar And B. Manohar, JJ.

IT Appeal No. 172 Of 2009

March  11, 2013

JUDGMENT

N. Kumar, J. – This appeal is by the assessee challenging the order passed by the Income Tax Appellate Tribunal (hereinafter referred to as ‘the Tribunal’) partly allowing the appeal filed by the assessee holding that the real income of the Bank has to be computed on the basis of the RBI guidelines when the claim of the assessee on erosion but investments available for sale is not allowable because it does not have the ingredient of stock in trade and hence no depreciation thereon can be allowed.

2. Assessee is the Banking institution. As per the Reserve Bank of India (RBI) Master Circular dated 01-09-2003, the assessee is required to classify the securities held into category of:

(a) ‘Available for Sale’

(b) ‘Held to Maturity’ &

(c) ‘Held for Trading’.

The assessee treated such securities as stock-in-trade and claimed depreciation on book value after valuing the Securities at lowest of cost or market value as consistently followed earlier. The revenue refusing to accept the assessee’s plea that classification of Securities as per RBI guidelines was not mandatory for the purpose of computing income under the Act and observed that assessee’s treatment of securities held as stock-in-trade valued at lowest of cost or market rate, was defective and violation of RBI guidelines. Therefore, the assessee’s claim of depreciation on securities under Income Tax Act, 1961 is not allowable on the whole Investment Portfolio’ (Securities) which is classified as ‘stock-in-trade’.

3. The assessee in its reply dated 19-07-2006 stated that though the classification is relevant only for the purpose of actual provisions in the accounts and not for the purpose of computing the real/taxable income and requested that depreciation in the value of investments be allowed as this is being claimed consistently and allowed as such in the income tax assessment during the last more than two decades in case of the Banks. However, the Assessing Authority over-ruled the said objection. The amount of Rs. 21,57,38,957/- was disallowed and added back to the total income of the assessee. Aggrieved by the said order, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals). The Appellate Authority dismissed the appeal upholding the contention of the Assessing Authority. Aggrieved by the said order, the assessee preferred an appeal to the Tribunal. The Tribunal held that the Securities held to maturity investment are not in the nature of stock-in-trade. Whether any erosion has taken place earlier is not found its place in a sum of Rs. 22.45 crores in the impugned assessment order. The real income of Bank has to be computed on the basis of the RBI guidelines when the claim of the assessee on erosion but investments valued for a sale is not allowable because it does not have ingredients of the stock-in-trade and hence no depreciation thereon can be allowed. It further recorded its finding that the securities on which, the depreciation has been claimed in earlier years has not been identified. Such erosion amounting to Rs. 22.45 crores has been claimed in the impugned assessment year against the depreciation in books at Rs. 12.35 crores. Therefore, the issue is restored to the file of the Assessing Officer for consideration in the light of the finding recorded above. Accordingly, the appeal was partly allowed and the matter was remitted to the Assessing Authority. Aggrieved by the said order, the present appeal is filed.

4. The following substantial question of law do arise for consideration in this appeal:

(i) Whether the Tribunal was justified in passing the impugned order with a finding that securities held by the assessee were not in the nature of stock-in-trade and denied the claim of depreciation when the said benefit was extended to the assessee for the earlier years; and

(ii) Whether the guideline of the RBI govern the treatment of securities as stock-in-trade for income tax purpose when the assessee has been consistently treating it as stock-in-trade which has been accepted by the revenue in the past.?

5. The said questions arose for consideration before the Apex Court in the case of Chainrup Sampatram v. CIT [1953] 24 ITR 481, wherein the Apex Court held as under:

“This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy. As profits for income-tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following year’s account in a business that is continuing are not brought into the charge as a matter of practice, though, as already stated, loss due to a fall in price below cost is allowed even if such loss has not been actually realized. As truly observed by one of the learned Judges in Whimster & Co. v. Commissioners of Inland Revenue, “Under this law (Revenue law) the profits are the profits realized in the course of the year. What seems an exception is recognized where a trader purchased and still holds goods or stocks which have fallen in value. No loss has been realized. Loss may not occur, Nevertheless, at the close of the year he is permitted to treat these goods or stocks as of their market value”.

In Whimster And Co. v. Commissioners of Inland Revenue [1926] 12 TC 813, it has been observed by the Apex Court as under:

With regard to maintenance of accounts, the Apex Court in Investment Ltd. v. CIT [1970] 77 ITR 533 observed as under:

“In the balance-sheet, it is true, the securities and shares are valued at cost, but no firm conclusion can be drawn from the method of keeping accounts. A taxpayer is free to employ, for the purpose of his trade, his own method of keeping accounts; and for that purpose to value his stock-in-trade either at cost or market price. A method of accounting adopted by the trader consistently and regularly cannot be discarded by the departmental authorities on the view that he should have adopted a different method of keeping account or of valuation. The method of accounting regularly employed may be discarded only if, in the opinion of the taxing authorities, income of the trade cannot be properly deduced therefrom. Valuation of stock at cost is one of the recognized methods. No inference may, therefore, arise from the employment by the company of the method of valuing stock at cost, that the stock valued was not stock-in-trade” (emphasis added).

The Apex court in the case of UCO Bank v. CIT [1999] 237 ITR 889/104 Taxman 547 observed as under:

“Under section 145 of the Income-tax Act, 1961, 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 present case, the method employed is entirely for a proper determination of income.”

Thereafter, the court further observed:

“The very fact that the assessee, although generally using a mercantile system of accounting, keeps such interest amounts in a suspense account and does not bring these amounts to the profit and loss account, goes to show that the assessee is following a mixed system of accounting by which such interest is included in its income only when it is actually received. Looking to the method of accounting so adopted by the assessee in such cases, the circulars which have been issued are consistent with the provisions of Section 145 and are meant to ensure that assesses of the kind specified who have to account for all such amounts of interest on doubtful loans are uniformly given the benefit under the circular and such interest amounts are not included in the income of the assessee until actually received if the conditions of the circular are satisfied.”

After referring the aforesaid judgments, the Apex Court in the case of United Commercial Bank v. CIT [1999] 240 ITR 355/106 Taxman 601 has held as under:

“Hence, for the purpose of income-tax whichever method is adopted by the assessee a true picture of the profits and gains, that is to say, the real income is to be disclosed. For determining the real income, the entries in a balance-sheet require to be maintained in the statutory form, may not be decisive or conclusive. In such cases, it is open to the Income-tax Officer as well as the assessee to point out the true and proper income while submitting the income-tax return.

The court held that whether the assessee is entitled to the particular deduction or not will depend upon the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter.”

Again, the Apex Court in the case of Southern Technologies Ltd. v. Jt. CIT [2010] 320 ITR 577/187 Taxman 346dealing with the effect of RBI Directions and Guidelines while computing the taxable income or accounting under the Income-tax Act held as under.

30. As stated above, the Companies Act allows an NBFC to adjust a provision for possible diminution in the value of asset or provision for doubtful debts against the assets and only the net figure is allowed to be shown in the balance-sheet, as a matter of disclosure. However, the said RBI Directions 1998 mandates all NBFs to show the said provisions separately on the liabilities side of balance-sheet, i.e., under the head “Current liabilities and provisions”. The purpose of the said deviation is to inform the user of the balance-sheet of the particulars concerning quantum and quality of the standard assets. Similarly, the 1998 directions does not recognize the “income” under the mercantile system and it insists that NBFCs should follow the cash system in regard to such incomes.

31. Before concluding on this point, we need to emphasise that the 1998 directions has nothing to do with the accounting treatment or taxability of “income” under the Income-tax Act. The two, viz., the Income-tax Act and the 1998 Directions operate in different fields. As stated above, under the mercantile system of accounting, interest/hire charges income accrues with time. In such cases, interest is charges and debited to the account of the borrower as “income” is recognized under the accrual system. However, it is not so recognized under the 1998 Directions and, therefore, in the matter of its presentation under the said directions, there would be an add back but not under the Income-tax Act necessarily. It is important to note that collectability is different from accrual. Hence, in each case, the assessee has to prove, as has happened in this case with regard to the sum of Rs. 20,34,605, that interest is not recognized or taken into account due to uncertainty in collection of the income. It is for the Assessing Officer to accept the claim of the assessee under the Income-tax Act or not to accept it in which case there will be add back even under the real income theory as explained hereinbelow.

Scope and applicability of the RBI Directions 1998

32. RBI Directions 1998 have been issued under section 45JA of the RBI Act. Under that section, power is given to RBI to enact a regulatory framework involving prescription of prudential norms for NBFCs which are deposit taking to ensure that NBFCs function on sound and healthy lines. The primary object of the said 1998 Directions is prudence, transparency and disclosure. Section 45JA comes under Chapter III-B which deals with provisions relating to financial institutions, and to non-banking institutions receiving deposits from the public. The said 1998 Directions touch various aspects such as income recognition; asset classification; provisioning, etc. As stated above, the basis of the 1998 Directions is that anticipated losses must be taken into account but expected income need not be taken note of. Therefore, these Directions ensure cash liquidity for NBFCs which are not required to state true and correct profits, without projecting inflated profits. Therefore, in our view, the RBI Directions 1998 deal only with presentation of NPA provisions in the balance-sheet of an NBFC. It has nothing to do with the computation or taxability of the provisions for NPA under the Income-tax Act.

Therefore, that the RBI Directions of 1998 are only disclosure norms. They have nothing to do with the computation of total taxable income under the Income-tax Act or with the accounting treatment. The said Directions only lay down the manner of presentation of NPA provisions in the balance sheet of NBFC. It has nothing to do with the account treatment or taxability of income under the Income-tax Act. Both these Income-tax Act and 1998 Directions operate in different fields. Under the mercantile system of accounting, the interest/hire charges income accrues with time. In such cases, interest is charged and debited to the account of the borrower as “income” is recognized under accrual system. However, it is not so recognized under the 1998 Directions and, therefore, in the matter of its presentation under the said Directions, there would an add back but not under the IT Act necessarily. It is important to note that collectability is different from accrual. The primary object of 1998 Directions is prudence, transparency and disclosure. Section 45-JA comes in Chapter III B which deals with the provisions relating to financial Institutions, and to non-banking institutions receiving deposits from the public. The said 1998 Directions touch various aspects such as income recognition; asset classification, provisioning, etc. Basis of the 1998 Directions is that anticipated losses must be taken into account but expected income need not be taken note of. Therefore, these Directions ensure cash liquidity for NBFCs which are now required to state true and correct profits, without projecting inflated profits. Therefore, the RBI Directions of 1998 deal only with the presentation of NPA provisions in the balance sheet of an NBFC. It has nothing to do with the computation or taxability of the provisions for NPA under the IT Act. Though RBI Directions 1998 deviate from accounting practice as provided in the Companies Act, they do not override the provisions of the IT Act. Some companies, for example, treat write offs or expenses or liabilities as contingent liabilities. For example, there are companies which do not recognize mark to market loss on its derivative contracts either by creating reserve as suggested by ICAI or by charging the same to the P&L a/c in terms of Accounting Standards. Consequently, their profits and reserves and surplus of the year are projected on the higher side. Consequently, such losses are not accounted in the books, at the highest, they are merely disclosed as contingent liability in the Notes to Accounts. The point which we would like to make is whether such losses are contingent or actual cannot be decided only on the basis of presentation. Such presentation will not bind the authority under the IT Act. Ultimately, the nature of transaction has to be examined. In each case, the authority has to examine the nature of expense/loss. Such examination and finding thereon will not depend upon presentation of expense/loss in the financial statements of the NBFC in terms of 1998 Directions. Therefore, the RBI Directions and the IT Act operate in different fields. These Directions 1998 have nothing to do with the computation of taxable income. These Directions cannot over-rule the “permissible deductions” or “their exclusion” under the IT Act. The inconsistency between these Directions and Companies Act is only in the matter of income recognition and presentation of financial statements. The accounting policies adopted by the NBFC cannot determine the taxable income. It is well settled that the accounting policies followed by a company can be changed unless the Assessing Officer comes to the conclusion that such change would result in understatement of profits. Hence, as far as income recognition is concerned. Section 145 of the IT Act has no role to play.

6. However, reliance was placed by the Revenue on the judgment of this court in the case of CIT v. ING Vysya Bank Ltd. [2012] 208 Taxman 511/24 taxmann.com 51 wherein it was held as under:

“30. While any investment in security can definitely become part of the stock-in-trade of a banking institution, no relevant question in the context of the present examination will be as to the nature of the security and for what purpose and in what manner the security was held by the assessee-bank. Even though Sri. Parthasarathy, learned counsel for the assessee, has contended that the bank has all along been treating the entire investment in security as stock-in-trade and even otherwise the RBI itself not only had notified the 30% of the securities required to be held by a banking institution for complying with the RBI guidelines/regulations can be in current investment, the fact that the bank had treated all its investments in securities as stock-in-trade and further fact that the RBI had accorded permission to the bank to value such investment should be taken as a relevant and clinching circumstance to accept the stand of the assessee that securities were stock-in-trade, we are unable to accept the submission, only for the reason that any and every asset held by an assessee does not necessarily become stock-in-trade, it is only such merchandize of a businessman which is ready for sale, and is held for sale, that acquires the characteristic of stock-in-trade.”

7. It is submitted that against such demand assessee has preferred an appeal and is now pending before the Apex Court. As it is clear from the extraction of the judgment of the Hon’ble Supreme Court set up about, the reasoning adopted by this Court in ING VYSYA BANK’S case runs counter to the law declared by the Apex Court.

8. From the aforesaid judgments of the Apex Court, now it is clear that a method of accounting adopted by the tax payer consistently and regularly cannot be discarded by the Departmental authorities on the view that he should have adopted a different method of keeping the accounts or on valuation. Financial institutions like Bank, are expected to maintain accounts in terms of the RBI Act and its regulations. The form in which, accounts have to be maintained is prescribed under the aforesaid legislation. Therefore, the account had to be inconformity with the said requirements. RBI Act or Companies Act do not deal with the permissible deductions or exclusion under the IT Act. For the purpose of IT Act, if the assessee has consistently treating the value of investment for more than two decades as investment as stock-in-trade and claim depreciation, it is not open to the authorities to disallow the said depreciation on the ground that in the balance-sheet it is shown as investment in terms of the RBI Regulations. The RBI Regulations, the Companies Act and IT Act operate altogether in different fields. The question whether the assessee is entitled to particular deduction or not will depend upon the provision of law relating thereto and not the way, in which the entries are made in the books of accounts. It is not decisive or conclusive in the matter. For the purpose of IT Act whichever method is adopted by the assessee, a true picture of the profits and gains i.e. real income is to be disclosed. For determining the real income, the entries in the balance sheet is required to be maintained in the statutory form may not be decisive or conclusive. It is open to the Income Tax Officer as well as the assessee to point out true and proper income while submitting the income tax returns. Even if the assessee under some misrepresentation or mistake fails to make an entry in the books of accounts, although under law, a deduction must be allowed by the Income Tax Officer, the assessee will not lose any right on claiming or will be debarred from being allowed the deduction. Therefore, the approach of the authorities in this regard is contrary to the well settled legal position as declared by the Apex Court.

9. In the instant case, the assessee has maintained the accounts in terms of the RBI Regulations and he has shown it as investment. But consistently for more than two decades it has been shown has stock-in-trade and depreciation is claimed and allowed. Therefore, notwithstanding that in the balance sheet, it is shown as investment, for the purpose of Income-tax Act, it is shown as stock-in-trade. Therefore, the value of the stocks being closely connected with the stock market, at the end of the financial year, while valuing the assets, necessarily the Bank has to take into consideration the market value of the shares. If the market value is less than the cost price, in law, they are entitled to deductions and it cannot be denied by the authorities under the pretext that it is shown as investment in the balance sheet.

10. In that view of the matter, the order passed by the authorities holding that in view of the RBI guidelines, the assessee is estopped from treating the investment as stock-in-trade is not correct. That finding recorded by the authorities is hereby set aside. The appeal is allowed. The matter is remanded back to the Assessing Authority and he shall look into these entries in accordance with law and shall assess in terms of the law declared by the Apex Court and the assessee is entitled to the extension of the said benefit. Both the substantial questions of law are answered in favour of the assessee and against the Revenue.

Ordered accordingly. No costs.

[Citation : 356 ITR 549]