The Delhi High Court in CIT vs. Brahmaputra Capital & Financial Services Ltd. held that Unrealized Interest on Non-Performing Assets (NPA) cannot be taxed on notional basis.
The assessee is a Non-Banking Financial Company (NBFC) and had extended loans to various concerns. Interests had accrued on the said loans. The assessee had not received interest for more than six months from its debtors. As per the RBI instructions, NBFC’s are required to declare such advances as Non-Performing Assets (NPA) when accrued interest on them is not paid by the debtor for six months, continuously. Therefore, the assessee treated the advances to its debtors as ICD, as NPA. The Assessing Officer (AO), however, added interest as the assessee’s income holding that it had “accrued” to it even if it was actually unpaid as the assessee followed the mercantile system of accounting. The CIT (A) affirmed the AO’s order. The ITAT deleted such interest income. Revenue appealed before the High Court.
The Counsel for the Revenue argued that there was cross shareholding of three entities which were given credit facility and that fact distinguish them from normal defaulting debtors. It was further contended that the decision not to reflect revenue recognition and to treat interest payable as NPA could not be allowed. The Counsel pointed out that nearly 405 of the amounts advanced were to the three companies and that the Revenue had right to hold the transactions were not at arm’s length and that the declaration of advances as NPA could not be legally accepted.
The Counsel for the assessee relied on the judgement of Commissioner of Income Tax vs. Vishisht Chay Vyapar Ltd in which the division bench had ruled that RBI’s prudential banking norms directed towards banking and non-banking entities were binding as accounting standards under Section 145 of the Income Tax Act and reflection of income on notional basis did not reflect the realistic assessment of real income. He argued that the Supreme Court had also approved the decision of the High Court.
The division bench Comprising of Justice S. Ravindra Bhat and Justice A. K. Chawla affirming the decision of the Division Bench in the case of Commissioner of Income Tax vs. Vishisht Chay Vyapar Ltd observed “In view of the above reasoning, this court, in the absence of any findings that the cross holdings of the debtor companies was the predominant or sole reasoning for the assessee’s inability to recover its dues, is bound by the reasoning in Vishisht Chay Vyapar (supra); more so, given that the Supreme Court has given its imprimatur on that ruling. For these reasons, the revenue’s appeal has to fail; the question of law is answered against it and the appeal dismissed.”
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