# 1 S.C.R. 380 MIS. SOUTHERN TECHNOLOGIES LTD v. JOINT COMMISSIONER OF INCOME TAX, COIMBATORE

- **Citation:** [2010] 1 S.C.R. 380
- **Court:** Supreme Court of India
- **Decided:** 2010-01-11
- **Case number:** Civil Appeal No. 1337 of 2003
- **Bench:** S.H. Kapadia, Aftab Alam
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/1-s-c-r-380-mis-southern-technologies-ltd-v-joint-commissioner-of-income-tax-26583
- **Pages:** 59

## Headnote

Income Tax Act, 1961:
c
s.2(24) - Provision for NPA - Debited by NBFC to the
P&L Account - In terms of Para 9(4) of the RBI Directions
1998 - Whether the provision for NPA to be treated as income
under s.2(24) of the Act- Held: RBI directions· deal with the
presentation of the provision for NPA in the Balance Sheet
0
of NBFC - The Directions are only disclosure norms and are
not related with the computation of total taxable income under
IT Act or with the accounting treatment - Not to be treated as
"income" under s. 2(24) of the Act - RBI Directions 1998 -
Para 9(4).
E
s.36(1)(vii) - Provision for NPA debited to the P&L
Account by NBFC in terms of RBI Directions 1998 - Claim
for deduction under s.36(1)(vii) - Entitlement for - Held: Not
entitled as the provision does not constitute expense.
F
s.36(1)(viia) and s.43D - Different treatment for NBFC
and banks for deduction under s.36(1)(viia) and s.43D -
Constitutional validity of - Held: s. 36(1 )(viia) provides for
deduction not only in respect of "written off' bad debt but in
case of banks it extends the allowance also to any Provision
G for bad and doubtful debts made by banks which incentive is
not given to NBFCs - Banks face a huge demand from the
industry and at times face liquidity crunch - Thus, the line of
business operations of NBFCs and banks are quite different
- It is for this reason, apart from social commitments which
1-1
380
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 381
OF INCOME TAX, COIMBATORE
banks undertake, that allowances of the nature mentioned in
A
s.36(1)(viia) and 43D are often restricted to banks and not to
NBFCs - Neither s.36(1)(viia) nor s.43D violates Article 14 -
The test of "intelligible differentia" stands complied with -
Constitution of India, 1950 - Article 14, 19(1)(g).
B
RBI Directions 1998:
Scope and applicability of - Discussed.
Para 9(4) - Analysis of - Held: RBI directions deal with
the presentation of provision for NPA in the Balance Sheet C
of NBFC - The Directions do not recognize the "income"
under the mercantile system - IT Act and the 1998 Directions
operate in different fields -
The primary object of 1998
Directions is prudence, transparency and disclosure - The
basis of 1998 Directions is that anticipated losses must be o
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 - The nature of expenditure ·
under the IT Act cannot be conclusively determined by the
E
manner in which accounts are presented in terms of 1998
Directions - RBI Directions 1998, though deviate from
accounting practice as provided in the Companies Act, do not
override the provisions of the IT Act - Income Tax Act, 1961
- Companies Act, 1956.
F
The question which arose for consideration in these
appeals filed by Non-Banking Financial Companies
(NBFC) is whether the "Provision for NPA", which in
terms of RBI Directions 1998 is debited to the P&L
Account is to be treated as "income" under Section 2(24)
G
of the Income Tax Act, 1961 while computing the profits
and gains of the business under Sections 28 to 430 of
the Act.
Dismissing the appeals, the Court
H
A
382
SUPREME COURT REPORTS
[201 O] 1 S.C.R.
HELD: 1.1. The RBI Directions 1998 deal with
Presentation of NPA provision in the Balance Sheet of an
NBFC. By Para 9 of 1998 Directions, RBI mandated that
every NBFC should disclose in its Balance Sheet, the
Provision without netting them from the Income or from
B the value of the assets and that the provision should be
distinctly indicated under the separate heads of accounts
as: - (i) provisions for bad and doubtful debts, and (ii)
provisions for depreciation in investments in the Balance
Sheet under "Current Liabilities and Provisions" and that
C such provision for each year should be debited to P&L
Account so that a true and correct figure of "Net Profit"
gets reflected in the financial accoun

## Text

_Characters 0–39,564 of 103,278. This is a partial read: ask again with offset=39564 for what follows._

A
B
(2010) 1 S.C.R. 380
MIS. SOUTHERN TECHNOLOGIES LTD.
v.
JOINT COMMISSIONER OF INCOME TAX, COIMBATORE
(Civil Appeal No. 1337 of 2003)
JANUARY 11, 2010
[S.H. KAPADIA AND AFTAB ALAM, JJ.]
Income Tax Act, 1961:
c
s.2(24) - Provision for NPA - Debited by NBFC to the
P&L Account - In terms of Para 9(4) of the RBI Directions
1998 - Whether the provision for NPA to be treated as income
under s.2(24) of the Act- Held: RBI directions· deal with the
presentation of the provision for NPA in the Balance Sheet
0
of NBFC - The Directions are only disclosure norms and are
not related with the computation of total taxable income under
IT Act or with the accounting treatment - Not to be treated as
"income" under s. 2(24) of the Act - RBI Directions 1998 -
Para 9(4).
E
s.36(1)(vii) - Provision for NPA debited to the P&L
Account by NBFC in terms of RBI Directions 1998 - Claim
for deduction under s.36(1)(vii) - Entitlement for - Held: Not
entitled as the provision does not constitute expense.
F
s.36(1)(viia) and s.43D - Different treatment for NBFC
and banks for deduction under s.36(1)(viia) and s.43D -
Constitutional validity of - Held: s. 36(1 )(viia) provides for
deduction not only in respect of "written off' bad debt but in
case of banks it extends the allowance also to any Provision
G for bad and doubtful debts made by banks which incentive is
not given to NBFCs - Banks face a huge demand from the
industry and at times face liquidity crunch - Thus, the line of
business operations of NBFCs and banks are quite different
- It is for this reason, apart from social commitments which
1-1
380
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 381
OF INCOME TAX, COIMBATORE
banks undertake, that allowances of the nature mentioned in
A
s.36(1)(viia) and 43D are often restricted to banks and not to
NBFCs - Neither s.36(1)(viia) nor s.43D violates Article 14 -
The test of "intelligible differentia" stands complied with -
Constitution of India, 1950 - Article 14, 19(1)(g).
B
RBI Directions 1998:
Scope and applicability of - Discussed.
Para 9(4) - Analysis of - Held: RBI directions deal with
the presentation of provision for NPA in the Balance Sheet C
of NBFC - The Directions do not recognize the "income"
under the mercantile system - IT Act and the 1998 Directions
operate in different fields -
The primary object of 1998
Directions is prudence, transparency and disclosure - The
basis of 1998 Directions is that anticipated losses must be o
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 - The nature of expenditure ·
under the IT Act cannot be conclusively determined by the
E
manner in which accounts are presented in terms of 1998
Directions - RBI Directions 1998, though deviate from
accounting practice as provided in the Companies Act, do not
override the provisions of the IT Act - Income Tax Act, 1961
- Companies Act, 1956.
F
The question which arose for consideration in these
appeals filed by Non-Banking Financial Companies
(NBFC) is whether the "Provision for NPA", which in
terms of RBI Directions 1998 is debited to the P&L
Account is to be treated as "income" under Section 2(24)
G
of the Income Tax Act, 1961 while computing the profits
and gains of the business under Sections 28 to 430 of
the Act.
Dismissing the appeals, the Court
H
A
382
SUPREME COURT REPORTS
[201 O] 1 S.C.R.
HELD: 1.1. The RBI Directions 1998 deal with
Presentation of NPA provision in the Balance Sheet of an
NBFC. By Para 9 of 1998 Directions, RBI mandated that
every NBFC should disclose in its Balance Sheet, the
Provision without netting them from the Income or from
B the value of the assets and that the provision should be
distinctly indicated under the separate heads of accounts
as: - (i) provisions for bad and doubtful debts, and (ii)
provisions for depreciation in investments in the Balance
Sheet under "Current Liabilities and Provisions" and that
C such provision for each year should be debited to P&L
Account so that a true and correct figure of "Net Profit"
gets reflected in the financial accounts of the company.
The effect of such Disclosure is to increase the current
liabilities by showing the provision against the possible
0 Loss on assets classified as NPA. An NPA continues to
be an Asset - "Debtors/ Loans and Advances" in the
books of NBFC. The entire exercise mentioned in the RBI
Directions 1998 is only in the context of Presentation of
NPA provisions in the balance sheet of an NBFC and it
has nothing to do with computation of taxable income or
E accounting concepts. [Paras 6 and 7] [420-E; 421-B-F]
1.2. The net profit shown in the P&L Account is the
basis for NBFC to accept deposits and declare dividends.
Higher the profits higher is the NOF and higher is the
F increase in the public making deposits in NBFCs. Hence
the object of the NBFC is disclosure and provisioning. By
insertion (w.e.f. 1.4.1989) of a new Explanation in Section
36(1 )(vii), it has been clarified that any bad debt written
off as irrecoverable in the account of the assessee will
G not include any provision for bad and doubtful debt made
in the accounts of the assessee. The said amendment
indicates that before 1.4.1989, even a provision could be
treated as a write off. However, after 1.4.1989, a distinct
dichotomy is brought in by way of the said Explanation
H to Section 36(1)(vii). Consequently, after 1.4.1989, a mere
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 383
OF INCOME TAX, COIMBATORE
provision for bad debt would not be entitled to deduction A
under Section 36(1 )(vii). If an assessee debits an amount
of doubtful debt to the P&L Account and credits the
asset account like sundry debtor's Account, it would
constitute a write off of an actual debt. However, if an
assessee debits "provision for doubtful debt" to the P&L
B
'
Account and makes a corresponding credit to the
"current liabilities and provisions" on the Liabilities side
of the balance sheet, then it would constitute a provision
for doubtful debt. In the latter case, assessee would not
be entitled to deduction after 1.4.1989. [Paras 7 and 8) c
[421-G-H; 422-D-H; 423-A]
Commissioner of Income Tax v. Jwala Prasad Tewari 24
ITR 537, relied on.
Vithaldas H. Dhanjibhai Bardanwala v. Commissioner of D
Income-Tax, Gujarat-V 130 ITR 95; Commissioner of
Income-Tax v. Woodward Governor India P. Ltd., 312 ITR
254; Commissioner of Income-tax, A.P. v. T. Veerabhadra
Rao K. Koteswara Rao & Co. 155 ITR 152, referred to.
2.1. The three deviations between RBI directions 1998 E
and Companies Act, are: in the matter of presentation of
financial statements under Schedule VI of the Companies
Act; in not recognising the "income" under the
mercantile system of accounting and iis insistence to
F
follow cash system with respect to assets classified as
NPA as per its Norms; and in creating a provision for all
NPAs summarily as against creating a provision only
when the debt is doubtful of recovery under the norms
of the Accounting Standards issued by the Institute of
G
Chartered Accountants of India. These deviations prevail
over certain provisions of the Companies Act, 1956 to
protect the Depositors in the context of Income
Recognition and Presentation of the Assets and
Provisions created against them. Thus, the P&L Account
prepared by NBFC in terms of RBI Directions 1998 does
H
384
SUPREME COURT REPORTS
[201 OJ 1 S.C.R.
A
not recognize "income from NPA" and, therefore, directs
a Provision to be made in that regard and hence an "add
back. The "add back" is there only in the case of
provisions. The Companies Act allows an NBFC to adjust
a Provision for possible diminution in the value of asset
B 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 NBFCs to show the said
provisions separately on the Liability Side of Balance
C 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, the particulars
concerning quantum and quality of the diminution in the
value of investment and particulars of doubtful and subD standard assets. Similarly, the 1998 Directions does not
recognize the "income" under the mercantile system and
it insists that NBFCs should follow cash system in regard
to such incomes. The 1998 Directions has nothing to do
with the accounting treatment or taxability of "income"
under the IT Act. The two, viz., IT Act and the 1998
E Directions operate in different fields. Under the mercantile
system of accounting, interest I 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
F
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 IT Act
necessarily. [Para 9] [424-C-H; 425-B-F]
G
2.2. RBI Directions 1998 were issued under Section
45JA of RBI Act. The primary object of the said 1998
Directions is prudence, transparency and disclosure. The
basis of the 1998 Directions is that anticipated losses
must be taken into account but expected income need
H not be taken note of. Therefore, these Directions ensure
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 385
OF INCOME TAX, COIMBATORE
cash liquidity for NBFCs which are now required to state
A
true and correct profits, without projecting inflated profits.
The nature of expenditure under the IT Act cannot be
conclusively determined by the mariner in which
accounts are presented in terms of 1998 Directions. RBI
Directions 1998, though deviate from accounting practice
B
as provided in the Companies Act, do not override the
provisions of the IT Act. [Para 10) [426-A-E]
2.3. Provision for NPA in terms of RBI Directions 1998
does not constitute expense on the basis of which C
deduction could be claimed by NBFC under Section
36(1)(vii). Provision for NPAs is an expense for
Presentation under 1998 Directions and in that sense it
is notional. For claiming deduction under the IT Act, one
has to go by the facts of the case (including the nature
of transaction). One must keep in mind another aspect.
D
Reduction in NPA takes place in two ways, namely, by
recoveries and by write off. However, by making a
provision for NPA, there will be no reduction in NPA.
Similarly, a write off is also of two types, namely, a regular
write off and a prudential write off. If one keeps these
E
concepts in mind, it becomes very clear that RBI
Directions 1998 are merely prudential norms. They can
also be called as disclosure norms or norms regarding
presentation of NPA Provisions in the Balance Sheet.
They do not touch upon the nature oi expense to be
F
decided by the AO in the assessment proceedings. [Para
10) [428-B-F]
Advance Accounts by Shukla, Gravel, Gupta, referred
to.
G
2.4. "Income Tax is a tax on the "real income", i.e.,
the profits arrived at on commercial principles subject to
the provisions of the Income Tax Act. The real profit can
be ascertained only by making the permissible
deductions under the provisions of the Income Tax Act.
H
386
SUPREME COURT REPORTS
[2010] 1 S.C.R.
A There is a clear distinction between the real profits and
statutory profits. The latter are statutorily fixed for a
specified purpose. Therefore, if by Explanation to Section
36(1)(vii) a provision for doubtful debt is kept out of the
ambit of the bad debt which is written off then, one has
B to take into account the said Explanation in computation
of total income under the IT Act failing which one cannot
ascertain the real profits. This is where the concept of
"add back" comes in. A provision for NPA debited to P&L
Account under the 1998 Directions is only a notional
c expense and, therefore, there would be add back to that
extent in the computation of total income under the IT Act.
Under Section 36(1 )(vii) read with the Explanation, a "write
off' is a condition for allowance. [Para 11] [429-A-B-E-G;
430-D]
D
Poona Electric Supply Co. Ltd. v. Commissioner of
Income-Tax, Bombay City I, 57 ITR 521; Commissioner of
Wealth- Tax, Bombay v. Bombay Suburban Electric Supply
Ltd. 103 ITR 384, relied on.
E
2.5. Section 36(1 )(vii) after 1.4.1989 draws a
distinction between write off and provision for doubtful
debt. The IT Act deals only with doubtful debt. It is for the
assessee to establish that the provision is made as the
loan is irrecoverable. However; in view of Explanation
F which keeps such a provision outside the scope of
"written off' bad debt, Section 37 cannot come in. If an
item falls under Sections 30 to 36, but is excluded by an
Explanation to Section 36(1)(vii) then Section 37 cannot
come in. Section 37 applies only to items which do not
G fall in Sections 30 to 36. If a provision for doubtful debt
is expressly excluded from Section 36(1)(vii) then such
a provision cannot claim deduction under Section 37 of
the IT Act even on the basis of "real income theory. [Para
14] [432-C-F]
H
3. Section 430 is similar to Section 438. The reason
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 387
OF INCOME TAX, COIMBATORE
B
for enacting this Section is that interest from bad and
A
doubtful debts in the case of bank and financial
institutions is difficult to recover; taxing such income on
accrual basis reduces the liquidity of the bank without
generation of income. With a view to improve their
viability, the IT Act has been amended by inserting
Section 430 to provide that such interest shall be
charged to tax only in the year of receipt or the year in
which it is credited to the P&L Account, whichever is
earlier. In the context of Article 14 of the Constitution, the
test to be applied is that of "rational/ intelligible c
differentia" having nexus with the object sought to be
achieved. Risk is one of the main concerns which RBI
has to address when it comes to NBFCs. NBFCs accept
deposits from the Public for which transparency is the
key, hence, the RBI Directions/ Norms. On the other hand,
0
as far as banking goes, the weightage, one must place
on, is on "liquidity". These two concepts, namely, "risk"
and "liquidity" bring out the basic difference between
NBFCs and Banks. An asset is rated as NPA when over
a period of time it ceases to get converted to cash or
E
generate income and becomes difficult to recover.
Therefore, Parliament realized that taxing such "income"
on accrual basis without actual recovery would create
liquidity crunch, hence, Section 430 came to be enacted.
Section 36(1)(viia) provides for a deduction not only in
respect of "written off'' bad debt but in case of banks it
extends the allowance also to any Provision for bad and
doubtful debts made by banks which incentive is not
given to NBFCs. Banks ,face a huge demand from the
industry particularly in an emerging market economy and
F
at times the credit offtake is so huge that banks face
G
liquidity crunch. Thus, the line of business operations of
NBFCs and banks are quite different. It is for this reason,
apart from social commitments which banks undertake,
that allowances of the nature mentioned in Sections
36(1)(viia) and 430 are often restricted to banks and not
H
388
SUPREME COURT REPORTS
(2010] 1 S.C.R.
A to NSFCs. Even in the case of banks, the Provision for
NPA has to be added back and only after such add back
that deduction under Section 36(1)(viia) can be claimed
by the banks. Neither Section 36(1)(viia) nor Section 430
violates Article 14. The test of "intelligible differentia"
B stands complied with. [Paras 15 and 16] (432-G-H; 433A-B; 434-8-H; 435-A-C]
c
D
E
F
G
R.K. Garg v. Union of India (1981) 4 SCC 675; Bhavesh
D Parish v. Union of India, (2000) 5 SCC 471; State of
Madras v. V.G. Row 1952 SCR 597, relied on.
Barclays Mercantile Business Finance Ltd. v. Mawson
(Inspector of Taxes), 2005 (1) All ER 97, referred to.
Case Law Reference:
130 ITR 95
referred to
Para 3
312 ITR 254
referred to
Para 4
155 ITR 152
referred to
Para 8
24 ITR 537
relied on
Para 8
57 ITR 521
relied on
Para 11
103 ITR 384
relied on
Para 11
(1981) 4 sec 675
relied on
Para 11
(2000) 5 sec 471
relied on
Para 16
1952 SCR 597
relied on
Para 16
2005 (1) All ER 97
referred to
Para 16
CIVIL APPELLATE JURISDICTION : Civil Appeal No.
1337 of 2003.
From the Judgment & Order dated 23.1.2002 of the High
Court of Judica~ure at Madras in Tax Case (Appeal No. 1 of
H 2002).
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 389
OF INCOME TAX, COIMBATORE
WITH
Crl. Appeal No. 154 of 2010 T.C. 5 & 6 of 2005.
A
Vivek Tankha, ASG, Arvind Datar, Dr. Debi Prosad Pal,
Radha Rangaswamy, Pritesh Kapur, J. Balachander, K.V.
8
Mohan, Ananda Sen, Dayan Krishnan, N.L. Rajah, Gautam
Narayan, Nikhil Nayyar, Lakshmi Iyengar, Ashok K. Srivastava,
Arijit Prasad, C.V. S. Rao, B.V. Balaram Das for the appearing
parties.
The Judgment of the Court was delivered by
S.H. KAPADIA, J. 1. Leave granted in the Special Leave
Petition.
2. Introduction
An interesting question of law which arises for
determination in these Civil Appeals filed by Non-banking
Financial Companies ("NBFCs" for short) is:
"Whether the Department is entitled to treat the "Provision
for NPA", which in terms of RBI Directions 1998 is debited
to the P&L Account, as "income" under Section 2(24) of
the Income Tax Act, 1961 ("IT Act" for short}, while
computing the profits and gains of the business under
Sections 28 to 43D of the IT Act?"
3. Facts
For the sake of convenience, we may refer to the facts in
the case of M/s. Southern Technologies Ltd. [Civil Appeal No.
c
D
E
F
1337 of 2b03].
G
At the outset, it may be stated that categorization of assets
into doubtful, sub-standard and loss is not in dispute.
The financial year of the Appellant is July to June and the
P&L Account arfc:J .the Balance Sheet are drawn as on 30th
H
390
SUPREME COURT REPORTS
[2010] 1 S.C.R.
A June. ·r he P&L Account and Balance Sheet is for shareholders,
Reserve Bank of India (RBI) and Registrar of Companies
(ROC) under the Companies Act, 1956. However, for IT Act, a
separate P&L Account is made out for the year ending 31st
March and the Balance Sheet as on that date is prepared and
B submitted to the Assessing Officer(AO) for computing the Total
Income under the IT Act, which is not for use of RBI or ROC.
For the accounting year ending 31.03.1998, Assessee
debited Rs. 81,68,516/- as Provision against NPA in the P&L
C Account on three counts, viz., Hire-Purchase of Rs .. 57,38,980/
-, Bill Discounting of Rs. 12,79,500/- and Loans and Advances
of Rs. 31,84, 701/-, in all, totalling Rs. 1,02,03, 121/- from which
AO allowed deduction of Rs. 20,34,605/- on account of Hire
Purchase Finance Charges leaving a balance provision for
NPA of Rs. 81,68,516/-.
D
Before the AO, Assessee claimed deduction in respect of
Rs. 81,68,516/- under Section 36(1)(vii) being Provision for
NPA in terms of RBI Directions 1998 on the ground that
Assessee had to debit the said amount to P&l Account [in
E terms of Para 9(4) of the RBI Directions] reducing its Profits,
contending it to be write off. In the alternative, Assessee
submitted that consequent upon RBI Directions 1998 there has
been diminution in the value of its assets for which Assessee
was entitled to deduction under Section 37 as a trading loss.
F This led to matters going in appeal (s). To conclude, it may be
stated that following the judgment of the Gujarat High Court in
the case of Vitha/das H. Dhanjibhai Bardanwala v.
Commissioner of Income-Tax, Gujarat-V 130 ITR 95, the IT AT
held that since Assessee had debited the said sum of Rs.
G 81,68,516/- to the P&L Account it was entitled to claim
deduction as a write off under Section 36(1 )(vii) which view was
not accepted by the High Court, hence, this batch of Civil
Appeal (s) are filed by NBFCs.
H
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 391
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
4. Submissions
A
Appellant made "Provision for NPA" amounting to Rs.
81,68,516/- for the financial year ending 31st March, 1998. This
was calculated as per Para 8 of the Prudential Norms 1998.
Accordingly, the P & L Account was debited and corresponding
B
amount was shown in the Balance Sheet. The Department
sought to add back Rs. 81,68,516/- to the taxable income on
the ground that the provision for bad and doubtful debt was not
allowable under Section 36(1)(ilii) of the IT Act. The appellant
claimed that the "Provision for NPA", however, represented c
"loss" in the value of assets and Jvas, therefore, allowable under
Section 37(1) of the IT Act. This claim of the appellant was
dismissed on the ground that the provisions of Section 36(1)(vii)
of the IT Act could not be by-passed.
The basic submission of the appellant in the lead case
D
before us was that an amount written off was allowable on the
basis of "real income theory" as well as on the basis of Section
145 of the IT Act. In this connection, the appellant submitted that
it was bound to follow the method of accounting prescribed by
RBI in terms of Paras 8 and 9 of the Prudential Norms 1998.
E
As per the said method of accounting, the "Provision for NPA"
actually represented depreciation in the value of the assets and,
consequently, it is deductible under Section 37(1) of the IT Act.
In this connection, appellant placed reliance on the judgment
of this Court in Commissioner of Income-Tax v. Woodward
F
Governor India P. Ltd., 312 ITR 254. According to the
appellant, applying "real income theory", the "Provision for NPA';
which is debited to-P&L Account in terms of the RBI Directions
1998 and shown accordingly in the Balance Sheet can never
, be treated as income under Section 2(24) of the IT Act and
G
added back while computing profits and gains of business
under Sections 28 to 43D of the IT Act.
In reply, the Department contended before us that the IT
Act is a separate code by itself; that the taxable total income
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392
SUPREME COURT REPORTS
[2010] 1 S.C.R.
A has to be computed strictly in terms of the provisions of the IT
Act; that the Reserve Bank of India Act, 1934 ("RBI Act" for
short) operates in the field of monetary and credit system and
that the said RBI Act never intended to compute taxable income
of NBFC for income tax purposes; and, hence, there was no
B inconsistency between the two Acts.
According to the Department, RBI has classified all assets
on which there is either a default in payment of interest or in
repayment of the principal sum for more than the specified
period as NPA. According to the Department, NPA does not
C mean that the asset has gone bad. It still continues to be an
asset in the books of the lender, i.e., NBFC under the head
"Debtors/Loans and Advances". According to the Department,
RBI as a regulator wants NBFCs who accept deposits from the
public to provide for a possible loss. The RBI Directions 1998
D insists that non-payment on Due Date alone is sufficient for
creation of a "Provision for NPA" (hereinafter referred to as
"provision"). In this connection, it was submitted that even if a
borrower repays his entire loan liability subsequent to the
closing of the Books on 31st March, say on 10th April, even
E then as per the RBI Directions 1998, a provision has to be
created to cover a possible loss. According to the Department,
even applying "real income theory" as propounded on behalf
of the assessee(s), the said theory presupposes that not only
income but even expenditure or loss incurred should be real.
F According to the Department, "Provision for NPA" is definitely
not an expenditure nor a loss, it is only a provision against
possible loss and, therefore, it is not open to the appellant(s)
to claim deduction for such provision under Section 36(1)(vii)
of the IT Act, as it stood at the material time. The only object
G behind RBI insisting on an NBFC to make "Provision for NPA"
compulsorily is to enable NBFC to state its profits only after
compulsorily creating a "Provision for NPA" because it is the
net profit of NBFC which is the base to determine its capacity
to accept deposits from the public. More the profit more they
H can accept deposits. According to the Department, vide RBI
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 393
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
Directions 1998, RBI tries to bring out the Profit in the P&L A
Account after providing for NPA which profit will be the
minimum profit that the company would make so that the real
or true and correct profit earned by an NBFC shall not be
anything lesser than what is disclosed. According to the
Department, the said "Provision for NPA" is in substance a B
"Reserve", which has been named as a "Provision" in the RBI
Directions 1998 to protect the depositors of NBFC. According
to the Department, even under accounting concepts, a provision
for possible diminution in value of an asset is a reserve. In this
connection, the Department has given three illustrations -
C
Depreciation Reserve, Reserve against Long Term
Investments, and Reserve against bad and doubtful debts.
According to the Department, as per accounting principles,
reserves are normally adjusted against the assets and only a
net figure is shown in the balance sheet. However, RBI, in the D
case of NBFC, has deviated from the above accounting
concept by insisting that the provision for NPA shall not be
netted against the assets and should be shown separately on
the liability side of the balance sheet so as to inform its user
about the quantum and quality of NPA, in a more transparent
manner. To this extent, there is a deviation from Part I of E
Schedule VI to the Companies Act, 1956.
Coming to the scope of Section 145 of the IT Act, it was
submitted by the Department that Section 145 occurs in
Chapter IV of the IT Act which deals with computation of total F
income. It indicates how the taxable income should be arrived
at vide Sections 14 to 59. It is not an assessment Section.
Section 145 helps to arrive at taxable total income. It nowhere
indicates that the net profit arrived at shall be by adopting the
accounting standards of Institute of Chartered Accountants of G
India (ICAI). It is the 1998 Directions which inter a/ia states that
NBFC shall not recognize any iq_come from an asset classified
as NPA on mercantile system of accounting and that such
Income shall be recognized only on cash basis. In the case
under appeal, the Assessing Officer, in his wisdom, has not H
394
SUPREME COURT REPORTS
[2010] 1 S.C.R.
A
considered Rs.20,34,605/- as "income" (being income accrued
on mercantile system of accounting) and did not include the
same in computing the total income.
According to the Department, under the accounting
B
concepts, a provision is a charge against a profit, whereas, a
reserve is an appropriation of profit. According to the
Department, the RBI Directions 1998 are not in conflict with the
provisions of the IT Act, however, they constitute deviations to
the presentation of the financial statements indicated in Part I
of Schedule VI to the Companies Act, 1956. For example,
C
under the 1998 Directions, Income from NPA under mercantile
system of accounting is not recognized and to that extent it
insists on NBFCs following the cash system of accounting.
Thus, the P&L Account prepared by NBFC shall not recognise
income from NPA but it shall create a provision by debit to the
D
P&L Account on all NPAs. Similarly, under the said 1998
Directions, there is insistence on creation of a provision in
respect of all NPAs summarily as against creation of a
provision only when the debt is doubtful of recovery. These
deviations are made mandatory with the paramount object of
E
protecting the interest of the depositors, even though they are
against accounting concepts. To the extent of these above
mentioned specific deviations, the RBI Directions 1998 shall
prevail over the provisions of the Companies Act (See Section
450 of the RBI Act). Therefore, according to the Department,
F
inconsistency in terms of Section 450 of the RBI Act is only
with respect to the Compariies Act, 1956 so far as it relates to
Income recognition and Presentation of assets and
Presentation of Provision/ Reserve created against NPAs and
not with the IT Act. According to the Department, if the argument
G that Section 450 prevails over the IT Act is accepted, then
various incomes like dividend income, agricultural income,
profit on sale of depreciable assets, capital gains, etc. which
items are all credited to P&L Account, but, which are exempted
under the IT Act would become taxable income which is not the
H intention of Section 450 of the IT Act. That, the said 1998
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 395
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
Directions cannot be taken as an excuse by the NBFC to
A
compute lower taxable income under the IT Act.
B
In rejoinder, it has been submitted on behalf of the
appellant(s} /assessee(s) that even if "Provision for NPA" is
treated to be in the nature of a reserve still it will not convert a
statutory debit in the P&L Account or a statutory charge in the
said Account as "real income". It is contended that under
Section 145 of the IT Act, NBFCs are bound to follow the
method of accounting prescribed by RBI. Hence, a statutory
debit or a statutory charge under RBI Directions 1998 issued c
under Section 45JA of the RBI Act cannot form part of the "real
income" and, consequently, it cannot be subjected to tax under
the IT Act. According to the appellant(s}, the "real income
theory" is concerned with determining whether a particular
amount can be treated as taxable income based on commercial
0
principles. According to the appellant(s}, the statutory provision
for NPA represents an amount forming part of the value of the
asset that the assessee is entitled to, but not likely to receive.
According to the appellant(s), they are in the business of
lending of money, financing by way of hire purchase, leasing
or bill discounting. According to the appellant(s), on default,
interest as well as the principal remains unrealized and, thus,
the "provision for NPA" provides for a diminution in the amounts
realizable (assets) and, consequently, "provision for NPA"
cannot be treated as "real income" and added back to the
taxable income of NBFCs, as is sought to be done by the
Department. According to the appellant(s), they have never
asked for deduction under Section 36(1 )(vii) of the IT Act. It is
E
F
the case of the appellant(s) that if one applies "real income
theory", "Provision for NPA" cannot be added back to the
income of NBFCs, as is sought to be done by the Department.
G
It is this "add back" which is impugned in the present case.
According to the appellant(s), when RBI Act has specifically
used the words "provision", "reserves", "assets'', etc., it is not
permissible to treat a "provision for NPA" mentioned in the
1998 Directions as a "reserve" for income tax proceedings.
H
396
SUPREME COURT REPORTS
[2010) 1 S.C.R.
A
According to the appellant(s), the RBI Directions 1998
provides for a mandatory method of accounting. It inter alia
mandates Income recognition of NPA on cash basis and not
on mercantile basis as required by Section 209(3) of the
Companies Act. It lays down, vide para 8, the "provisioning
B requirements" which have got to be followed and the aggregate
amount whereof has got to be debited to the P&L Account.
According to appellant(s), para 8 of the 1998 Directions shows
that the "Provision for NPA" takes into account diminution in
value of the security charge, hence, it was, under Section 37
c of the IT Act, entitled to deduction. According to the appellant(s),
Section 451A of the RBI Act defines "NOF". The Explanation (I)
to the said Section defines "NOF" as the aggregate of paidup equity capital and free reserves. According to the
appellant(s), if "Provision for NPA" is treated as reserve, it
D would increase the NOF of the company and, consequently, the
higher the provision for NPAs, higher will be the net worth of
the company which could never have been the intention or
objective of the RBI Directions 1998. Further, according to the
appellant(s), in view of a statutory reserve fund which has to be
/E created by all NBFCs under Section 451C, the "Provision for
NPA" can never be treated as one more another type of
reserve.
Coming to the accounting treatment, the appellant has
given us the following chart to bring out the difference between
F "provision" and "reserve":
S.No. Provision
Reserve
1.
Provision is a charge or Reserve is an appropriation
debit to the P& L
of profits.
G
Account.
2.
Provision is made
No reserve can be created
against gross receipts in in accounting year when
the P & L Ale irrespecthere is a loss.
tive of whether there is
H
profit or loss.
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 397
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
Provisions are a pretax
Reserves are created out of
charge to P & L account post-tax profits, by way of
irrespective of whether
appropriation, subject to
the NBFC makes a net
there being adequate net
profit or not.
profit.
3.
If NPA is Rs. 10 lakhs,
If NPA is Rs. 10 lakhs, and
then the accounting entry there is a loss, no "Reserve
is:
can be created.
P&L Ale Dr. 10,00,000
To Prov. for
NPA 10,00,000
If there is a loss, the
debit of Rs. 10,00,000/-
will increase the quantum
of loss. This aggregate
loss will be shown on the
assets side as debit
balance of P&L Ale.
4.
Provision is based on a Reserves are based on a
one-stage entry:
two stage accounting
P&L Ale Dr.
process under the horizontal
To Prov. for
system. If the profits are Rs.
Excise/ PF/ Gratuity/ etc. 10 crores, the Board of
Directors may transfer Rs. 8
crores to P&L Appropriation
Ale for taxation, dividend and
reserve. The balance will be
transferred to credit balance
of P&L Ale. The entries will
be as follows:-
Stage 1:
P&L Ale Dr. 10.00
To P&L
A
B
c
D
E
F
G
H
398
SUPREME COURT REPORTS
[2010] 1 S.C.R.
A
Appropriation Ale
8.00
To P& L Ale
2.00
Stage 2:
P&L Appropriation Ale 8.00
To Prov. Taxation
4.00
To Prov. for Dividends 2.00
B
To Transfer to Reserve 2.00
Thus, if there are no profits,
there can be no debit to the
c
reserve. Under the vertical
system, "profits available for
appropriation" are post-tax
profits. Appropriation to
reserves can be made only
D
when there is a surplus.
5.
Under Clause 7(1)(a) of Under Clause 7(1 )(b) of Part
Part- Ill of Schedule VI
- Ill of Schedule - VI of
of Companies Act, 1956 Companies Act, 1956 -
- provision, inter alia,
reserve does not include
E
is to provide for depreany amount written off or
ciation, renewals or
retained by providing for
diminution in value of
depreciation, renewals, etc.
assets or to provide
or providing for any known
for any taxation.
liability. Under Part - I of
F
Schedule .i- VI, 'reserve' can
be made in respect of
capital reserves, capital
redemption, share premium,
etc.
G
5.
Provision cannot be
Reserves can be utilized to
used to declare dividend pay dividends/ bonus,
etc.
unless there is a statutory
bar.
H
SOUTHERN TECHNOLOGIES LTD v. JOINT COMMNR. 399
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
Lastly, on the question of adding back to the taxable
A
income, it has been submitted on behalf of the appellant(s) that
the profits arrived as per the P&L Account under the
Companies Act are after debiting several provisions under
various accounting heads. There are several statutory liabilities
like provision for excise duty, gratuity, provident fund, ESI, etc.
The IT Act disallows several such provisions under Sections
40A(7), 43B, 40 and 40A. Such disallowances alone could be
added back to the taxable income. The IT Act does not disallow
B
a provision for NPA; that, unless the "provision for NPA'~ is
specifically disallowed under the IT Act, the same cannot be c
added back and, hence, such a provision for,NPA cannot be
added back in computing the taxable income. According to the
appellant, the purpose behind prescribing RBI Directions 1998
is to ensure that members of the public and shareholders of
the company obtain a true picture of the financial health of the o
company. Its purpose is not to create a notional income.
According to the appellant, in the present case, only a method
of accounting has been prescribed by RBI. This accounting
method cannot be used by the Department to assume existence
of an income when such income does not really exist and,
E
consequently, add back to the taxable income is not
contemplated by the IT Act, nor is it contemplated under the
"real income theory", however, if at all it has to be taken into
account, it should be made all,owable as a loss under Section
37(1) of the IT Act.
F
5. Relevant Provisions
(a)
Of RBI Act, 1934
Chapter l/IB - PROVISIONS RELATING TO NONBANKING INSTITUTIONS RECEIVING DEPOSITS
G
AND FINANCIAL INSTITUTIONS
Section 451 - Definitions
In this Chapter, unless the context otherwise requires,-
H
400
A
B
c
SUPREME COURT REPORTS
[2010) 1 S.C.R.
(a) "business of a non-banking financial institution"
means carrying on the business of a financial institution
referred to in clause (c) and includes business of a nonbanking financial company referred to in clause (f);
(aa) "company" means a company as defined in section
3 of the Companies Act, 1956 (1 of 1956), and includes
a foreign company within the meaning of section 591 of
that Act;
(c) "financial institution" means any non-banking institution
which carries on as its business or part of its business any
of the following activities, namely:-
(i) the financing, whether by way of making loans or
advances or othervise, of any activity other than its own;
D
(ii) the acquisition of shares, stock, bonds, debentures or
securities issued by a Government or local authority or
other marketable securities of a like nature;
(iii) letting or delivering of any goods to a hirer under a hireE
purchase agreement as defined in clause (c) of section 2
of the Hire-Purchase Act, 1972 (26 of 1972);
F
G
H
(iv) the carrying on of any class of insurance business;
(v) managing, conducting or supervising, as foreman, agent
or in any other capacity, of chits or kuries as defined in
any law which is for the time being in force in any State,
or any business, which is similar thereto;
(vi) collecting, for any purpose or under any scheme or
arrangement by whatever name called, monies in lump sum
or otherwise, by way of subscriptions or by sale of units,
or other instruments or in any other manner and awarding
prizes or gifts, whether in cash or king, or disbursing
monies in any other way, to persons from whom monies
are collected or to any other person,
SOUTHERN TECHNOLOGIES LTD. v. JOINT COMMNR. 401
OF INCOME TAX, COIMBATORE [S.H. KAPADIA, J.]
A
but does not include any institution, which carries on as its
principal business,-
(a) agricultural operations; or
(aa) industrial activity; or
Explanation.-For the purposes of this clause, "industrial
activity" means any activity specified in sub-clauses (i) to
(xviii) of clause (c) of section 2 of the Industrial
Development Bank of India Act, 1964 (18 of 1964);
(b) the purchase, or sale of any goods (other than
securities) or the providing of any services; or
B
c
(c) the purchase, construction or sale of immovable
property, so, however, that no portion of the income of the
0
institution is derived from the financing of purchases,
constructions or sales of immovable property by other
persons;
45-IA.