High Court Of Karnataka
CIT, Central Circle, Bangalore vs. Canfin Homes Ltd.
Assessment Year : 1997-98
Section : 5 , 145
N. Kumar And Ravi Malimath, JJ.
IT Appeal No. 801 Of 2006
August 1, 2011
N. Kumar, J. – The above appeal was admitted to consider the following two substantial questions of law:—
“1. Whether the Appellate Tribunal was right in holding that interest income from Bonds of National Housing Bank and dividend income which was offered to tax by the assessee under the head “Income from other sources” should be assessed under the head “Business income” and deduction under section 36(1)(viii ) of the Act should be allowed?
2. Whether the Tribunal was right in holding that income from non-performing assets should be assessed on cash basis and not on mercantile basis despite the assessee maintaining mercantile system of accounting?”
2. Insofar as the first substantial question of law is concerned, this Court in the case of the very same assessee in ITA No. 3159/2005 decided on 5-7-2010 held that in respect of any special reserve created by any financial corporation which is engaged in providing long term finance for industrial or agricultural development or infrastructure facility in India, an amount not exceeding 40 per cent of the total income computed before making any deduction under these clauses and Chapter VI-A carry to such reserve account. In other words, in computing the total income, no deduction under that clause as well as under Chapter VII has to be made. To such deduction, one has to find out what is the total income and then, an amount not exceeding 40 per cent of the total income could be deducted from the taxable income under the heading ‘Profits and gains’. In view of the stand taken by this Court in the aforesaid appeal in the case of the assessee. we do not see any justification to take any other view other than what is been held in that case. Therefore, the substantial question of law No. 1 is answered in favour of the assessee and against the revenue.
3. Insofar as the second substantial question of law is concerned, the learned counsel for the revenue contended in view of section 145 which came into force from 1-4-1997, when once the assessee computes his income in accordance with mercantile system of accounting regularly, the income accrued from non-performing asset, whether actually received or not, is to be taken into consideration in computing the total income and tax is payable thereon and therefore, he submits the question of exempting that income when the assessee is following mercantile system of accounting is contrary to section 145(2) of the Income-tax Act, 1961.
4. In order to appreciate this contention, it is necessary to look into the said section as it stands today.
“145. Method of accounting.—(1) Income chargeable under the head “Profits and gains of business or profession” or ‘Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified, under sub-section (2), have not been regularly followed by the assessee the Assessing Officer may make an assessment in the manner provided in section 144.”
5. A reading of the aforesaid provision makes it very clear that section 145(1) is subject to the provisions of sub-section (2). Sub-section (2) provides that the Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. Therefore, it is clear the requirement of complying with cash or mercantile system of accounting is subject to the directions to be issued by the Central Government in the matter of accounting standards. After the amendment to section 145 the Board has issued accounting standards to be followed by way of a Notification No. SO 69(E), dated 25-1-1996. Clause (4) of the accounting standards reads as under:—
“4. Accounting policies adopted by an assessee should be such so as to represent a true and fair view of the state of affairs of the business, profession or vocation in the financial statements prepared and presented on the basis of such accounting policies. For this purpose, the major considerations governing the selection and application of accounting policies are prudence, substance over form and materiality.”
6. Clause 6 defines ‘accrual’ for the purpose of paragraphs (1) to (5) in the said accounting standards. ‘Accrual’ refers to the assumption, that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. Relying on this definition in the accounting standard, the revenue contends it is immaterial whether any revenue is actually received or not. If it is shown to accrued that is sufficient to charge the said income. In this context it is also necessary to take note of the guidelines dated 28-4-1995 issued by the National Housing Bank with reference to non-performing asset which is the subject-matter of these proceedings. It states the policy on income recognition to be objective should be based on record of recovery. Income from non-performing asset (NPA) may not be recognized merely on the basis of accrual. An asset becomes non-performing when it ceases to yield income. The income from NPAs, therefore, should be recognized only when it is actually received. NPA is an asset in respect of which interest has remained unpaid and has become ‘past due’. An amount is to be treated as ‘past due’ when it remains unpaid for 30 days beyond the due date. Interest on NPAs should not be booked as income if such interest has remained outstanding for more than six months on and from March 31, 1995. In fact this question arose for consideration before the Apex Court in the case of State Bank of Travancore v. CIT  158 ITR 102 / 24 Taxman 337 where it has been held that, the concept of reality of the income and the actuality of the situation are relevant factors which go to the making up of accrual of income but once accrual takes place and income accrues, the same cannot be defeated by any theory of real income. The concept of real income cannot be so used as to make accrued income non-income simply because after the event of accrual, the assessee neither decides to treat it as a bad debt nor claims deduction under section 36(2) of the Act, but still enters the same with a diminished hope of recovery in the suspense account. Extension of the concept of real income to this field to negate accrual after the amount had become payable is contrary to the postulates of the Act.
7. Again the Apex Court in the case of UCO Bank v. CIT  237 ITR 889 / 104 Taxman 547 held that, 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 also 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 that all Income-tax Officers should treat such amounts as not forming part of the income of the assessee until realized, this direction by way of a circular cannot be considered as travelling beyond the powers of the Board under section 119 of the Income-tax Act. Such a circular is binding under section 119. Such circulars are meant for ensuring proper administration of the statute and, they are designed to mitigate the rigours of the application of a particular provision of the statute in certain situations by applying a beneficial interpretation of the provision in question.
8. Therefore, it is clear, if an assessee adopts mercantile system of accounting and in his accounts he shows a particular income as accruing, whether that amount is really accrued or not is liable to bring the said income to tax. His accounts should reflect true and correct statement of affairs. Merely because the said amount accrued was not realised immediately cannot be a ground to avoid payment of tax. But, if in his account it is clearly stated though a particular income is due to him but it is not possible to recover the same, then it cannot said to have been accrued and the said amount cannot be brought to tax. In the Instant case we are concerned with a non-performing asset. As the definition of non-performing asset shows an asset becomes non-performing when it ceases to yield income. Non-performing asset is an asset in respect of which interest has remained unpaid and has become past due. Once a particular asset is shown to be a non-performing asset, then the assumption is it is not yielding any revenue. When it is not yielding any revenue, the question of showing that revenue and paying tax would not arise. As is clear from the policy guidelines issued by the National Housing Bank, the income from non-performing asset should be recognised only when it is actually received. That is what, the Tribunal held in the instant case. Therefore, the contention of the revenue that in respect, of non-performing assets even though it does not yield any income as the assessee has adopted a mercantile system of accounting, he has to pay tax on the revenue which has accrued notionally is without any basis. In that view of the matter, the second substantial question framed is answered against, the revenue and in favour of the assessee.
9. For the aforesaid reasons we do not see any merit in the appeal. Accordingly, the appeals is dismissed.
[Citation : 347 ITR 382]