Co-op Bank Interest Tax Dispute: Court Clarifies Rules on Member Interest and Non-Performing Assets

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Case Name: 

Commissioner of Income Tax Vs Basaceshwara Sahakari Bank (High Court of Karnataka)

ITA No.100132 of 2014

Date: 16th August 2016

Key Takeaways:

1. Interest paid to co-operative bank members above Rs.10,000 was not taxable before June 1, 2015.

2. Interest receivable from non-performing assets, including bad and doubtful debts, can be deducted if not reflected in the profit and loss account.

3. The court's decision aligns with previous rulings, reinforcing the interpretation of tax laws for co-operative banks.

Issue:

The court addressed two main questions:

1. Should interest paid to members of a Co-operative Bank above Rs. 10,000 be added to tax?

2. Can interest receivable from non-performing assets, bad and doubtful debts be deducted if not reflected in the profit and loss account?

Facts:

The case involves a dispute between the Commissioner of Income Tax and Basaveshwara Sahakari Bank. The specific details of the bank's operations are not provided in the judgment. However, the case revolves around the bank's tax treatment of interest paid to members and interest receivable from non-performing assets.

Arguments:

While the specific arguments of each party are not detailed in the judgment, we can infer that:

1. The tax authorities likely argued that interest paid to members above Rs. 10,000 should be taxable and that interest receivable from non-performing assets should not be deductible.

2. The bank likely argued for the non-taxability of member interest payments and the deductibility of interest from non-performing assets.

Key Legal Precedents:

1. ITA No.100116/2014 between the Commissioner of Income Tax and another vs. The Bagalkot District Central Co-operative Bank (dated 16.12.2015): This case, referencing Government of India circular No.19/2015, established that co-operative banks were not required to deduct tax from interest payments on time deposits to members before June 1, 2015.

2. Commissioner of Income-Tax and another vs. Canfin Homes Ltd. (2012) 347 ITR 382 (Karn): This case dealt with the treatment of non-performing assets, establishing that income from such assets should only be recognized when actually received.

Judgement:

The court ruled in favor of the bank on both issues:

1. Interest paid to members: The court affirmed that before June 1, 2015, co-operative banks were not required to deduct tax from interest payments on time deposits to members exceeding Rs.10,000.

2. Non-performing assets: The court held that interest receivable from non-performing assets, including bad and doubtful debts, can be deducted if not reflected in the profit and loss account. The court clarified that non-performing assets include various categories such as substandard assets, doubtful assets, and loss assets.

The court based its decision on previous judgments and disposed of the appeal accordingly.

FAQs:

1. Q: When did co-operative banks start having to deduct tax on interest payments to members?

  A: Co-operative banks were required to start deducting tax on interest payments to members for time deposits on or after June 1, 2015.

2. Q: What constitutes a non-performing asset?

  A: A non-performing asset is a loan or advance where interest and/or principal installments remain overdue for more than 90 days, or the account remains "out of order" for more than 90 days in case of overdrafts/cash credits.

3. Q: How are non-performing assets classified?

  A: Non-performing assets are classified into three categories: (a) Sub-standard Assets, (b) Doubtful Assets, and (c) Loss Assets.

4. Q: Does this judgment apply to all co-operative banks?

  A: While the judgment specifically addresses the case of Basaveshwara Sahakari Bank, it relies on precedents that would likely apply to other co-operative banks in similar situations.

5. Q: How does this judgment impact the accounting practices of co-operative banks?

  A: This judgment reinforces that co-operative banks can deduct interest receivable from non-performing assets when it's not reflected in their profit and loss account, potentially affecting how they report their income for tax purposes.

Heard the learned counsel for the parties.

2. The following substantial questions of law arise for consideration in this appeal;

i) Whether the interest paid to members of a Co-operative Bank above Rs.10,000/- should be added to tax or not?

ii) Whether interest receivable from non-performing assets, bad and doubtful debts though the actual expression used is interest payable and not reflected in the profit and loss account, could be deducted?

3. The learned counsel for the parties submit that the matter is covered by a decision of this Court in ITA No.200002/2015 and connected appeals.

4. This Court in ITA No.200002/2015 and connected appeals has raised the following substantial questions of law in addition to one more question regarding gratuity;

i) Whether the interest paid to members of a Co-operative Bank above Rs.10,000/- should be added to tax or not?

ii) Whether interest receivable from non-performing assets, bad and doubtful debts though the actual expression used is interest payable and not reflected in the profit and loss account, could be deducted?

5. The first question is answered at para 2 as follows:

“ 2. ...... The point is squarely covered by a Division Bench judgment of this Court in ITA No.100116/2014 between the Commissioner of Income Tax and another vs. The Bagalkot District Central Co-operative Bank dated 16.12.2015 wherein, with reference to a circular of the Government of India bearing No.19/2015 in F.No.142/14/2015 TPL, it has been held as follows:

“42.5 In view of this, the provisions of the section 194(3)(v) of the Income Tax Act, 1961 have been amended so as to expressly provide that the exemption provided from deduction of tax from payment of interest to members by a co- operative society under Section 194A(3)(v) of the Income Tax Act, 1961 shall not apply to the payment of interest on time deposits by the co-operative banks to its members. As this amendment is effective from the prospective dated of 1st June, 2015, the co-operative bank shall be required to deduct tax from the payment of interest on time deposits of its members, on or after the 1st June 2015. Hence, a cooperative bank was not required to deduct tax from the payment of interest on time deposits of its members paid or credited before 1st June 2015.”

In view of the above circular, the said substantial question of law does not survive for consideration.”

6. The second question is answered at para 5 as follows:

“ 5. One other substantial question of law framed is,“Whether interest receivable from non- performing assets, bad and doubtful debts though the actual expression used is interest payable and not reflected in the profit and loss account, could be deducted?”

In this regard, the learned counsel for the assessee has produced a judgment of this Court in Commissioner of Income-Tax and another vs. Canfin Homes Ltd. (2012) 347 ITR 382 (Karn) with reference to non-performing assets. The Division Bench of this Court has held as follows:

“ Therefore, it is clear, if an assessee adopts the 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 be said to have been accrued and the said amount cannot be brought to tax. In the instant case, were 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.”

At this, the learned counsel for the revenue would submit that the decision only refers to non- performing assets and it is not evident that non- performing assets would also cover other classification of loans and advances. In this regard, the learned counsel for the assessee would point out that non- performing assets would include the other categories of substandard assets, doubtful assets, loss assets, etc., all of which would come within the purview of non- performing assets. In this regard, he would draw attention to the prudential norms for income recognition, asset classification and provisioning pertaining to advances.

Volume I of ‘Tannan’s Banking Law and Practice in India’, has extracted these prudential norms in line with the international practices and as per the recommendations of the Narasimham Committee on the financial system, the Reserve Bank of India has introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the Banks so as to move towards greater consistency and transparency in the published accounts.

The definition of non-performing assets is as follows:

“1. Non-performing assets:

An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.

A “non-performing asset” (NPA) is a loan or an advance where:

(i) the interest and / or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan;

(ii) the account remains “out of order” for a period of more than 90 days as indicated below, in respect of an Overdraft / Cash Credit (OD/CC);

(iii) the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted;

(iv) the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops;

(v) the instalment of principal or interest thereon remains overdue for one crop seasons for long duration crops.

Banks should, classify an account as NPA only if the interest charged during any quarter is not serviced fully within 90 days from the end of the quarter.”

Further, asset classification which is separately dealt with reference to categories of non-performing assets, as follows:

“Banks are required to classify non- performing assets further into the following three categories based on the period for which the asset has remained non- performing and the realisability of the dues:

(a) Sub-standard Assets

(b) Doubtful Assets

(c) Loss Assets”

Therefore, it is evident that the mere nomenclature adopted with reference to the bad loans and advances receivable, would refer to all non-performing assets of any nature, of whatever category it was placed as a non-performing asset and therefore, the decision of this court in Canfin Homes would squarely apply.

Accordingly, the above question of law also stands answered.

7. The decision in ITA No.200002/2015 and connected appeals is applicable to the substantial questions of law raised in this appeal also. Therefore, the substantial questions of law raised in this appeal are answered in terms of the order passed in ITA No.200002/2015 and connected appeals and the appeal is disposed of, accordingly.

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JUDGE

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JUDGE