Commissioner of Income-tax vs Karnataka Bank Ltd.

In these two appeals preferred by the Revenue, they have raised the following three substantial questions of law: "(1) Whether the Appellate Authorities were correct in reversing the finding of the Assessing Officer that the assessee was following dual method of accounting i.e., one method for arriving at book profits and another method for arriving at taxable income which was not permissible, as per Section 145(1) of the Act, after amendment, which was rectified resulting in addition of Rs. 7,24,96,894/- in respect of accrued interest on government securities (including broken period interest)?

(2) Whether the Appellate Authorities were correct in holding that no expenditure can be allotted to the exempted income earned by the assessee when the Assessing Officer had worked out 596 and the Appellate Commissioner had worked out 2.5% despite the assessee incurring expenditure for earning such income?

(3) Whether the Appellate Authorities were correct in holding that the bad debts of Rs. 45,32,983/- was an allowable deduction u/s. 36(1)(vii) of the Act despite the same having been deducted by the assessee in the computation made u/s. 36(1)(viia) of the Act and the express prohibition in Section 36(1)(vii) which restricts the amount of deduction allowable under that clause in cases where the assessee is entitled to claim deduction u/s. 36(1)(viia) of the Act?"

The First substantial question of law arose for consideration before this Court in the case of CIT v. Karnataka Bank Ltd. [IT Appeal No. 433 of 2006, dated, 12-9-2012], where it is answered as under: "16. It is declared U/s. 5 of the Act that when interest is accrued or deemed to have been accrued, it is liable to tax. The word ''accrued'' has defined the legal connotation. The interest that becomes due or liable to be payable whether or not it is paid, the interest is accrued or deemed to have been accrued. If the interest does not become due and not liable to pay such part of the interest arise it cannot be said that the interest has become accrued. It appears from the facts of the case that the assessee is a bank. For its accounting purpose, it has shown the proportionate interest entitled to receive on the Government securities. But for the assessment year, although it is not accrued, in the legal sense and in terms of Sections 5 and 145 of the I.T Act. The contention of the Revenue that in the books of account, the proportionate interest shown for the broken period in the balance sheet, should be construed as the income accrued, is not tenable. In other words, the income which has become due and payable should alone be considered as income accrued and that should be offered as tax. The contention that Assessing Officer is entitled to tax on the interest income although not due and payable as accrued, is untenable. The fact that the assessee in its internal books of accounting mentions the proportionate interest, which is entitled to receive, in its balance sheet for the purpose of profit and loss cannot be deemed as income accrued, unless such income has become due and payable. On the basis of such amount, the A.O. has no right to charge the interest, which has not become due and payable.

In fact, we find no inconsistency between the amended provisions of Sections 145 and 5 of the I.T. Act. It may be that the amended provisions of Sections 145 now insists mercantile system of accounting where on the income accrued the tax can be levied whether or not received unlike in cash system. Merely because in the books of account, the interest income, which is not due and payable is shown in the account of the assessee. That itself will not give right to A.O. to tax unless it has become due and payable as per provisions of Section 5 of the I.T. Act."

In view of the aforesaid judgment, the substantial question of law is accordingly answered in favour of the assessee and against the revenue.

Second substantial question of law also arose for consideration before this Court in the case of Canara Bank v. Asstt. CIT [IT Appeal No. 1397 of 2006] and other connected matters decided on 12.11.2013, where it has been held as under:

"11. This court, in Maharashtra Apex Corporation Limited case (supra) held, when no expenditure is incurred by an assessee in earning the dividend income, no notional expenditure could be deducted from the said income. Though benefit u/s. 80M is granted on the net income, when no expenditure is incurred in earning the dividend income, the gross income would become the net income. Thus, there is no scope for any estimation being made or any amount being deducted as notional expenditure.

In the instant case, facts set out above demonstrates the income is derived by the dividends u/s. 10(33) of the Act and interest on tax free bonds u/s. 10(15)(h) of the Act and interest on long term finance to infrastructure companies u/s. 10(23G) of the Act. In other words, the persons with whom the amounts are invested by the assessee are crediting the aforesaid amount to the assessee''s account by way of a bank transfer. Therefore, no human agency is involved in collecting these dividends and interest for which the assessee has to incur any expenditure. This is the consequence of computerization, online transaction through NEFT[National Electronic Fund Transfer], RTGS[Real Time Gross Settlement] and also DEMAT Accounts. The assessing authority should take note of these developments in deciding whether any expenditure is incurred in earning the said, income. The discussion by the assessing authority clearly demonstrates these aspects has not been taken note of and the notional expenditure is calculated pre-modernization. Therefore, in the light of the aforesaid Judgment, when the assessee has not incurred any expenditure for realizing this income, the question of holding that 2% of the gross total income is an expenditure and that has to be added back to the income is unsustainable in law. Accordingly, the substantial question of law is answered in favour of the assessee and against the revenue."

In the light of the aforesaid judgment, the substantial questions of law is answered in favour of the assessee and against the revenue.

Insofar as third substantial question of law is concerned, it involves the interpretation of Section 36(1)(vii) and Section 36(1)(viia) of the Act. On the day the authorities passed their order, they did not have the benefit of the judgment of the Hon''ble Apex Court in the case of Catholic Syrian Bank Ltd. Vs. Commissioner of Income Tax, Thrissur, , where the said provisions fell for consideration.

Interpretation placed by the three authorities are not in conformity with the interpretation placed by the Hon''ble Apex Court in the aforesaid judgment. Therefore, the impugned orders insofar as the said substantial questions of law are concerned cannot be sustained. Accordingly, it is set aside.

Before a finding is recorded on the said question, the aforesaid two provisions have to be taken note of and then in the light of the judgment rendered by the Hon''ble Apex Court the order is to be passed. Therefore as far as that aspect of the matter is concerned, we remand the matter back to the assessing authority with a direction to decide the said aspect in the terms of the judgment of the Hon''ble Supreme Court in the case of Catholic Syrian Bank Ltd. (supra).

Ordered accordingly.