D. Murali

FACTS of the TCI Finance case make interesting reading. The company incurred expenditure for conducting legal proceedings against defaulting debtors and claimed the outlay as business expenditure. But the assessing officer (AO) found that TCI's books showed that those amounts had been debited to the accounts of the defaulters, and not debited to the P&L A/c. Therefore, he said that the expenditure couldn't be claimed as business expenditure. On the income side also, there were differences between TCI and the AO.

While the company did not include Rs 1.2 crore of finance charges relating to customers whose principal repayment was `extremely doubtful', the AO insisted on including the amount in total income, applying `mercantile system of accounting.' Aggrieved thus, TCI appealed before the Commissioner, but he too concurred with the AO. So the issue landed up before the Hyderabad Income-Tax Appellate Tribunal (ITAT).

Income

On the income dispute, TCI submitted that RBI's Circular on prudential norms clearly lay down that income from non-performing assets (NPA) is to be recognised only on actual receipt, and not merely on the basis of accrual. The company argued that the mercantile system did not envisage taking into account hypothetical income; and that accrual of income has to be judged from a realistic point of view.

But the Department contended that income accrued as soon as the right to claim the amount got vested with TCI, irrespective of whether it was subsequently received or not.

"There is no objection to making entries in the books of account as per RBI norms," said the Department's counsel, and added that TCI had to pay tax according to the provisions of the Income-Tax Act.

To relax `the rigours of law', the CBDT has power to issue a circular beneficial to the assessee, reasoned the Department, and said that such power to issue beneficial circulars in the field of taxation was not given to the RBI. "Mere improbability of recovery cannot result into non-accrual of income," argued the Department, citing a horde of judgments. Text of the decision cites Accounting Standards (AS) notified by the CBDT, with interpretation by both the sides to their advantage.

Expenditure

How did the parties argue the expenditure spat? The Department argued, "Making a claim without duly reflecting the same in the books of account would lead to an incongruent situation." It said that the legal expenses go to the debtors' accounts and are to be realised from them "on final judgment", and if the claim is rejected by the court, it can be claimed as `crystallised expenditure' in the relevant previous year when proceedings come to an end. "Litigation expenses can actually be said to have crystallised only in the year in which the suit filed by the assessee is decided, and not in the years in which the litigation was pending," argued the Department.

In response, TCI said that legal expenses had been actually incurred "wholly and exclusively for business purposes." The company's counsel said, "The treatment of an expenditure in the books of account in a particular manner or existence or absence of an entry in the books of an assessee is neither determinative nor decisive for tax purposes."

Tribunal's reasoning

The order of Mr J. Sudhakar Reddy, Accountant Member, has a few offbeat lines on the drab subject of accounting:

"Mercantile system of accounting cannot be considered a mere mathematical model where subjective conclusions on realisability or otherwise of an income have no place." He did not find anything wrong in not recognising income when recovery of principal was doubtful. Also, TCI was consistently following the RBI guidelines in this regard, thus satisfying `consistency', a fundamental accounting assumption in AS-1.

Mr Reddy drew attention to `prudence' and `substance over form' as cornerstones of accounting. "Accounting policies mandated by the RBI are not contrary to AS-1," he declared. "In fact, they define what is `prudence' and also require assessees to go by the substance of the issue rather than the form."

What about the expenditure problem? Mr Reddy asked, "When on the issue of recognition of income we have given emphasis to AS 1's concepts such as consistency, prudence, method of accounting and so on, can it be said that when it comes to expenditure, the method of accounting and so on have no relevance?" Answer: "We do not think so." So, did the expenditure accrue? No, said the ITAT, based on the consistent method of accounting followed by TCI. "The assessee had followed AS 1 and found it prudent that no provision need be made under the mercantile system of accounting for this expenditure/liability," observed Mr Reddy. "Thus, as per the company's method of accounting, this expenditure had not crystallised during the relevant previous year."

While TCI won on the income side, it lost the expenditure battle. One wonders whether the Department would allow TCI to claim legal expenses of debating the row at the ITAT, or insist that the same be apportioned to all those defaulting debtors.

Ghastly taxman after ghostly interest

POYSHA Oxygen P Ltd vs Deputy Commissioner of Income-tax, reported recently, is another case on similar grounds. The company had given a loan of Rs 1 crore to Ganga Automobiles Ltd (GAL).

There was default in repayment, and Poysha initiated arbitration proceedings. No real income accrued and so Poysha did not show anything as interest income, but the AO was interested in adding up interest to the income, at 30 per cent penal rate.

Mr K. C. Singhal, Judicial Member of the Delhi ITAT, traced the evolution of law on the subject, citing cases such as CIT vs Shoorji Vallabhdas & Co, CIT vs Chamanlal Mangaldas & Co, and CIT vs Confinance Ltd, apart from decisions in the Morvi Industries Ltd and Ferozpur Finance P Ltd cases. The controversy about taxability of interest income on sticky or doubtful debts was resolved by the apex court in the State Bank of Travancore case, said Mr Singhal.

There it was held that the concept of real income could not be so read as to defeat the object and provisions of the statutory enactment. However, the issue resurfaced in the Shiv Prakash Janak Raj & Co case, and more recently in the Godhra Electricity case. For the benefit of the combating parties, Mr Singhal summarised the legal position thus: "If the income does not result at all to the assessee, then it cannot be taxed even though such income might have hypothetically accrued, or entries are made in the books of account of such hypothetical income."

In the current case, the Tribunal found that the debt was not merely doubtful, but bad. "As a prudent businessman, there was no question of crediting interest account in respect of such a loan," said Mr Singhal. "Ultimately, the assessee has not been able to recover even a fraction of the loan amount what to speak of interest amount." To the disappointed Department, he had this to say:

"The Revenue's case is not prejudiced as tax can still be levied in the years of recovery, if any."

When loans go bad, remember that worse may follow in the form of a ghastly taxman who sees the shadow of a ghostly interest in your books.

AccountSpeak@TheHindu.co.in

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