DEEPAK R. SHAH, A.M. OREDR Both these appeals by assessee are directed against orders of learned CIT(A)-I, Bangalore, dt. 7 th Aug., 2000. 1.1 first common issue in both appeals is whether income from SLR investment is to be treated as income from business or income from other sources. Consequently, whether assessee is entitled to deduction under s. 36(1)(viii) on such income. 2. appellant is housing finance company engaged in business of housing finance for purchase and/or construction of residential houses. appellant is recognized by M/s National Housing Bank (NHB) as well as by CBDT for purposes of s. 36(1)(viii) of IT Act, 1961. 2 . 1 appellant for purposes of meeting with SLR requirement, invested amounts to extent required in units of US-64 issued by Unit Trust of India as well as various Government and other notified bonds. appellant claimed statutory deduction allowable under s. 36(1)(viii) to housing finance company upon income earned on housing finance business, on dividend and interest earned on above investments. This was on account of fact that these investments were made exclusively on account of requirements of law governing business of housing finance. 2.2 AO taking cue from order passed by CIT(A) in respect of appeals of appellant relating to asst. yrs. 1996-9 7 and 199 7 -98 against prima facie adjustments made by AO while completing assessment under provisions of s. 143(1)(a) of IT Act, 1961, assessed income relating to SLR investments of appellant under head Income from other sources and disallowed statutory claim of appellant under s. 36(1)(viii), details of which are given below : Gross Statutory Asst. income from deduction under yr. interest on bonds s. 36(1)(viii) & dividends allowed claimed by by AO under appellant s. 143(3) 1996-9 7 Gross 6,49,69,814 3,49,48, dividends- 6,32,00,000 60,10,000 7 36 US-64 Interest on bonds 199 7 - 98 2,99,98, 7 Gross 80 3,8 7 dividends- 4,40,00,000 ,11,052 US-64 1,51,59,336 Interest on bonds 2 . 3 CIT(A) held that income from SLR investments, namely "dividends" and "interest" are required to be assessed under head Income from other sources and hence he upheld orders passed by AO as well as disallowance of statutory deduction under s. 36(1)(viii) claimed by appellant. He relied on provisions of ss. 56 and 5 7 of IT Act, 1961, which define that "dividends" are required to be assessed under head Income from other sources , and hence appellant was not eligible to statutory deduction under s. 36(1)(viii). 3 . Learned counsel for assessee Shri Balakrishna, chartered accountant submitted that being governed by s. 29B of National Housing Bank Act (NHB Act), he is statutorily required to invest and maintain investments of required percentage on deposits (deposits include loans taken by housing institution) in specified securities as otherwise his licence and recognition would be liable for cancellation under provisions of s. 29A of NHB Act, and without which he is not permitted to carry on business of housing finance. In other words investment in specified securities are nothing but part of housing finance business of appellant. 3.1 raw material required by appellant for carrying on his housing finance business is money and major source of money is from public deposits and loans from credit institutions and this could be raised by appellant only if he fulfils or complies with various provisions of NHB Act. Thus there is inseparable nexus between housing finance business as well as maintenance of SLR investments and one cannot exist without other and hence they do not form any separate activity but investments in SLR securities form part and parcel of very core housing finance activity of appellant. 3 . 2 investments in SLR securities were made on account of statutory provisions without which appellant had to close his business. "dividends" received by appellant were not same as referred to in provisions of s. 56 and s. 5 7 of IT Act, 1961. provisions of s. 2(28B), which refer/relate to interest on securities are applicable to case of appellant. income earned by appellant on SLR securities are nothing but income earned from his housing finance business, as they are part and parcel of business of housing finance. income earned from SLR investments are required to be assessed under head Income from housing finance business only. appellant is legally entitled to claim of statutory deduction under s. 36(1)(viii) allowable to him against his income from housing finance business which includes income from his SLR investments. 3.3 Shri Balakrishnan also relied upon following decisions : (1) Cambay Electric Supply Industrial Co. Ltd. vs. CIT 19 7 8 CTR (SC) 50 : (19 7 8) 113 ITR 84 (SC); (2) CIT vs. Paramount Premises (P) Ltd. (1991) 190 ITR 259 (Bom); (3) CIT vs. Madurai District Central Co-operative Bank Ltd. (199 7 ) 224 ITR 23 7 (Mad); (4) CIT vs. Amora Chemicals (P) Ltd. (2002) 1 7 8 CTR (Guj) 64 : (2002) 258 ITR 519 (Guj); (5) CIT vs. Ramanathapuram Dist. Co-op. Central Bank Ltd. (2002) 1 7 5 CTR (SC) 29 7 : (2002) 255 ITR 423 (SC); (6) ITO vs. Tamil Nadu Co-op. State Land Development Bank Ltd. (1981) 11 TTJ (Mad) 202; ( 7 ) Maharashtra State Co-op. Land Development Bank Ltd. vs. ITO (1992) 41 ITD 491 (Bom); (8) Centrex Publication (P) Ltd. vs. Dy. CIT (2003) 7 9 TTJ (Del) 265; (9) Asstt. CIT vs. Gallium Equipment (P) Ltd. (2001) 7 3 TTJ (Del)(TM) 130. 4 . Learned CIT-Departmental Representative, Shri Arun Bhatnagar strongly supported impugned orders. He submitted that under s. 56(2)(i) dividends are taxable only as income from other sources. Deduction under s. 36(1)(viii) is allowed only in respect of profit derived from business of long-term finance for purpose of housing. Such profit eligible for deduction is only such which is computed under head 'Profits and gains of business or profession . Since dividend is always taxable under head Income from other sources dividend from SLR investment cannot be included while computing profits and gains of business. 5 . We have carefully considered relevant facts and arguments advanced. As per provisions of NHB Act it is necessary to have recognition from nodal agency to carry on business of housing finance. appellant being recognized by NHB, is required to comply with rules and regulations laid down by NHB under said enactment. NHB is empowered to cancel licence and/recognition of housing finance company in event of any failure to comply with guidelines and rules issued by NHB from time-to-time. relevant provisions of NHB Act are as under : "Chapter V of NHB Act, 198 7 Sec. 29A : Requirement of registration and net owned funds (1) Notwithstanding anything contained in this chapter or in any other law for time being in force, no housing finance institution which is company shall commence or carry on business of housing finance institution without : (a) obtaining certificate of registration issued under this chapter and (b) having net owned fund of twenty-five lakhs rupees or such higher amount, as National Housing Bank may by notification specify. (6) National Housing Bank may cancel certificate of registration granted to finance institution under this section if such institution: (i) ceases to carry on business of housing finance institution in India; or (ii) has failed to comply with any condition subject to which certificate of registration had been issued to it; or (iii) at any time fails to fulfil any of conditions referred to in cls. (a) to (g) of sub-s. (4); or (iv) fails : (a) to comply with any direction issued by NHB under provisions of this chapter; or (b) to maintain accounts in accordance with requirement of any law or any direction or order issued by National Housing Bank under provisions of this chapter; or (c) to submit or offer for inspection its books of account and other relevant documents when so demanded by any inspecting authority of National Housing Bank; or (v) has been prohibited from accepting deposit by order made by National Housing Bank under provisions of this chapter and such order has been in force for period of not less than three months.. Sec. 29B : Maintenance of percentage of assets (1) Every housing finance institution shall invest and continue to invest in India in unencumbered approved securities, valued at price not exceeding current market price of such securities, amount which, at close of business on any day, shall not be less than five per cent or such higher percentage not exceeding twenty five per cent, as National Housing Bank may, from time-to-time and by notification, specify, of deposits outstanding at close of business of last working day of second preceding quarter..." 5.1 It is also relevant to know as to obligation of assessee to make investment in SLR securities and extent of investment, which is summarized as under : Computation of percentage and value of SLR Investments to be made as per 25-B of NHB Act Particulars Y/E 31-3-9 7 Y/E 31-3-96 Deposits I. Secured : 1. Debentures -- 10,50,00,000 10,50,00,000 (Non- convertible) 2. NHB Exempted 1,41,26,33,614 1,23,82,40,353 3. UTI -- 8, 7 5,00,000 11,25,00,000 4. Term -- 46,66, 7 9,065 7 1,21, 7 9,66 7 loan from bank 5. Overdraft from -- 5, 7 ,55,895 2,11,99 7 bank 7 Sub-total 92,98,91,664 ,16,62,34,960 II. Unsecured : Deposits -- 3,16,80, 7 ,946 2,66,81,21,62 7 from public Total 3,88,43,05,906 33,59,80,13,291 Minimum SLR to be 38,84,30,590 35,98,01,329 maintained @ 10% Invested 39, 7 ,88,100 38, 7 ,88,100 subject of making investment in SLR securities and business of housing finance are so much intertwined that they cannot exist without other and they are made for each other s purpose. requirement of making and maintaining these SLR investments are governed by statute and these statutes have been made by Parliament in its wisdom to protect interest of citizens and investors of this country, as well as to keep financial health of financial companies. business of finance is governed and controlled by nodal agency RBI and business of housing finance company are governed by NHB, which is wholly-owned subsidiary of RBI. What one has to look is whether appellant can carry on business of housing finance without making these investments in notified securities. answer would be No. In other words it is act of investment and resultant income namely, dividends and interest from these securities are nothing but part and parcel of housing finance business, and hence entitled to benefit of statutory deduction under s. 36(1)(viii). It is also necessary for us to consider and understand relevant provision of s. 36(1)(viii). provisions of s. 36(1)(viii) give relief to housing finance company only when it fulfils following conditions : (a) It must have been recognized by NHB (b) It also must be recognized by CBDT for purposes of s. 36(1)(viii) (c) assessee should create reserve out of his profits from his housing finance business (d) statutory deduction is limited to 40 per cent of income from housing finance business (long-term) or reserve created, whichever is less. 5 . 2 Learned CIT(A) failed to appreciate nature of activity of appellant and as well as position of law and simply applied provisions of s. 56 and s. 5 7 and passed orders which is against facts of case as well as position of law. There is certain difference between dividend referred in s. 56 as well as in s. 2(28B), which can be summarized as under : Dividends Income from units Dividends distributions by "Dividends" Being distribution by companies Unit Trust of India Definition : Interest on securities : Sec. 2(28B) Definition : A. US-64 is defined as security "Dividend" is defined and any income distribution by UTI on under s. 2(22) and is exclusively its US-64 scheme has to be brought to related to distribution of profits income-tax as interest on security. by "company" to its shareholder. B. member in US-64 scheme is not considered as "shareholder" and hence any distribution by UTI is not considered as "dividend" as per s. 2(22). Deduction of tax at source : Deduction of tax at source : Sec. 194A : Interest other than interest on securities Sec. 194 : Deals with deduction of tax at source while Sec. 193 : Interest on securities making payments by company Sec. 194K : Income in respect of to its shareholders. Units (including units of UTI) Statutory exemption : Statutory exemption : Income distributed by mutual "Dividends" are exempted funds in hands of members are under s. 10(23FA) exempted under s. 10(23D). Taxation : Taxation : Sec. 115-O : "Dividends" Sec. 115R "income distributed" by are taxed under s. 115-O at UTI is taxed under s. 15R at time of time of distribution. distribution. Defaults : Defaults : Sec. 115Q company will Sec. 115T : UTI is held liable for be liable for penal proceedings penalty for non payment of income-tax for default of remittance of at time of payment of "income income-tax while remitting distribution on units" (including US-64) dividends. Statutory deduction : Statutory deduction : Sec. 80L : Refers to Sec. 80L : Refers to statutory statutory deduction out of gross deduction out of gross income. income. For dividends : For income from US-64 Sec. 80L (iv) Sec. 80L(v). By purchasing units of UTI, assessee is not becoming shareholder of Unit Trust of India. Unit Trust of India is 100 per cent undertaking of Government of India and assessee is merely holding certain units of mutual fund scheme called US-64 floated by Government. It is different proposition that under UTI Act itself, income distributed is characterized s dividend and is also eligible for deduction under s. 80L, etc. However, income declared by UTI cannot be considered as equivalent to dividend distributed by company on shares issued by it. Hon ble Supreme Court in case of Cambay Electric Supply Industrial Co. Ltd. (supra) held that expression "attributable to" is having wider import than expression "derived from". Hon ble Supreme Court in case of CIT vs. Sterling Foods (1999) 153 CTR (SC) 439 : (1999) 23 7 ITR 5 7 9 (SC) held that to claim deduction under s. 80HH, industrial undertaking itself has to be source of profit. business of industrial undertaking should directly yield profit. industrial undertaking should be direct source of that profit and not means to earn profit. There must be direct nexus between profits and gains and industrial undertaking. In present case, it is seen that income by way of income distribution by mutual fund springs up from SLR investments statutorily required to be made. assessee for purpose of its business of housing finance, borrowed certain sums by way of non-convertible debentures, term loan from bank and deposit from public. In compliance with NHB Act, assessee was required to invest part of its liability in SLR securities. Thus, investment is made only in terms of statutory requirement and not by way of surplus funds available to assessee. activity of housing finance, borrowal for purpose of finance and statutory investment in compliance with NHB Act read with RBI Guidelines is part and parcel of business activity. Thus, income from such SLR investment is to be treated as business income and has to be computed under head Profits and gains of business or profession . Consequently, assessee is entitled to deduction under s. 36(1)(viii) as per law. This issue is accordingly decided in favour of assessee. 6 . next issue only for asst. yr. 199 7 -98 is whether income on non- performing assets is to be assessed on mercantile basis or on cash basis. 6.1 As stated earlier, appellant is housing finance company engaged in business of housing finance. As per provisions of NHB, it is necessary to have recognition from nodal agency to carry on business of housing finance. Accordingly, assessee is recognized by NHB. To carry on business, assessee is also to follow, provisions of NHB Act and guidelines issued to member banks by NHB from time-to-time. As per s. 36 o f NHB Act, provisions of Chapter V of NHB Act, 198 7 shall have effect notwithstanding anything inconsistent therewith contained in any other law for time being in force or any instrument having effect by virtue of any such law. guidelines issued by NHB under s. 30A known as prudential norms came into force from 1st April, 1995. As per said guidelines, assessee changed its method of accounting from mercantile system to cash system of accounting in respect of income on loans classified as "non-performing assets" (NPA). According to prudential norms prescribed by NHB, income on such non- performing assets can be recognized only after such income is received by housing finance company and not on basis of mere accrual. 6.2 AO, while concluding assessment, held that income on non-performing assets are required to be accounted and to be assessed on mercantile basis. As per amended provisions of s. 145, assessee cannot have mixed system of accounting. Since assessee is following mercantile system of accounting, income on such non-performing assets is deemed to have accrued and accordingly chargeable to tax. For this purpose, AO relied upon decision of Hon ble Supreme Court in case of State Bank of Travancore vs. CIT (1986) 50 CTR (SC) 290 : (1986) 158 ITR 102 (SC). Learned CIT(A) relied on amended s. 43D, which extends benefit of recognizing income on non-performing assets to National Housing Finance w.e.f. 1st April, 2000. Accordingly, he came to conclusion that appellant was not entitled to application of cash system of accounting in respect of NPA for asst. yr. 199 7 -98. As per Accounting Standards-1 and 2 as issued under s. 145 of IT Act, they merely stated that accounting policy adopted by assessee should be such so as to represent true and fair view of state of affairs. He accordingly confirmed addition. 6.3 Learned counsel for assessee submitted that as per provision of s. 30A of NHB Act, it is mandatory to follow direction of NHB in respect of recognition of income. As per such direction, income on NPA accounts has to be accounted only on cash basis and not on mercantile basis. Chapter V of NHB Act overrides all other laws including IT Act. provision of IT Act is not sparing from overriding provision of NHB Act and hence anything inconsistent in IT law is not applicable including recognition of income. Accounting standards-1 and 2 issued under s. 145 clearly laid down that if any different accounting policies prescribed under any other law (are) followed by assessee for recognition of income, then income shall be computed under such method and not under method prescribed in sub-s. (1) of s. 145 of IT Act. He accordingly pleaded that income on NPA accounts is to be accounted only on cash basis and not on mercantile basis. For this proposition he relied upon following cases : (1) Tedco Investment & Financial Services (P) Ltd. vs. Dy. CIT (2004) 82 TTJ (Del) 259 : (2004) 8 7 ITD 298 (Del); (2) TCI Finance Ltd. vs. Asstt. CIT (2005) 92 TTJ (Hyd) 238; (3) Sri Kewal Chand Bagri vs. CIT (1990) 183 ITR 20 7 (Cal); (4) CIT vs. Raigarh Jute Mills (1982) 26 CTR (Cal) 25 : (1981) 132 ITR 7 2 (Cal); (5) CIT vs. Bokaro Steel Ltd. (1999) 151 CTR (SC) 2 7 6 : (1999) 236 ITR 315 (SC); (6) CIT vs. UP State Industrial Development Corporation Ltd. (199 7 ) 139 CTR (SC) 26 7 : (199 7 ) 225 ITR 7 3 (SC); ( 7 ) CIT vs. British Paints India Ltd. (1991) 91 CTR (SC) 108 : (1991) 188 ITR 44 (SC); (8) Godhra Electric Co. Ltd. vs. CIT (199 7 ) 139 CTR (SC) 564 : (199 7 ) 225 ITR 7 46 (SC); (9) United Commercial Bank vs. CIT (1999) 156 CTR (SC) 380 : (1999) 240 ITR 355 (SC); (10) CIT vs. Method Trading & Investments Ltd. (2001) 165 CTR (Cal) 541 : (2000) 246 ITR 588 (Cal). 6 . 4 Learned Departmental Representative on other hand strongly supported appellate order. He submitted that as per s. 145, assessee c n have only one of two methods of accounting, i.e., either cash or mercantile. With effect from asst. yr. 199 7 -98, assessee cannot choose mixed system of accounting. Since assessee is undisputedly following mercantile system of accounting, interest, though on non-performing assets, accrues and is accordingly to be brought to tax. Since income is arising from same business of housing finance, cash system of accounting in respect of part of business is not permissible. issue is covered in favour of Revenue by decision of Hon ble Supreme Court in case of State Bank of Travancore (supra). 7 . We have carefully considered relevant facts and arguments advanced. As per s. 145 amended w.e.f. 1st April, 199 7 , income chargeable under head Profit and gains of business or profession is to be computed in accordance with either cash or mercantile system of accounting regularly employed by assessee. As per sub-s. (2) of s. 145, Central Government may notify in Official Gazette accounting standards to be followed by any class of assessees or in respect of any class of income. relevant portions of Accounting Standards 1 and 2 are reproduced below : "Accounting Standard-1 : Relating to disclosure of accounting policies : (4) "Accounting policies adopted by assessee should be such so as to represent true and fair view of state of affairs of business, profession or vocation in financial statements prepared and presented on basis of such accounting policies. For this purpose, major consideration governing selection and application of accounting policies are following namely : (i) Prudence : "provisions should be made for all known liabilities and losses even though amount cannot be determined with certainty and represents only best estimate in light of available information." Accounting Standard 2 : Relating to disclosure of prior period and extra- ordinary items and changes in accounting policies (9) "A change in accounting policy shall be made only if adoption of different accounting policy is required by statute or if it is considered that change would result in more appropriate preparation or presentation of financial statements by assessee." Undisputedly, assessee is registered housing finance company governed by NHB Act, 198 7 . Chapter V of NHB Act, 198 7 relating to housing finance companies receiving deposits shall have effect notwithstanding anything inconsistent therewith contained (in) any other law. NHB in exercise of powers available to it regulating working of housing finance company issued guidelines dt. 28th April, 1995 relating to prudential norms for income recognition, accounting standards, provisioning for bad and doubtful debts, capital adequacy and concentration of credit/investment. As per said guidelines, it was directed as under : "1. Income recognition and accounting standards. policy on income recognition to be objective should be based on record of recovery. Income from non-performing assets (NPA) may not be recognized merely on basis of accrual. asset becomes non-performing when it ceases to yield income. income from NPAs, therefore, should be recognized only when it is actually received. NPA is asset in respect of which interest has remained unpaid and has become past due . amount is to be treated as past due when it remains unpaid for 30 days beyond due date. Interest on NPAs should not be booked as income if such interest has remained outstanding for more than six months on and from 31st March, 1995. basis of treating credit facility as NPA should be as under : 1.1 Term loan beyond one year If interest amount remains past due for six months, term loan is to be treated as NPA. Where instalment is overdue for more than six months, entire outstanding loan, inclusive of unpaid interest, if any, should also be treated as NPA. 1.2 Lease, rentals/hire-purchase instalments Where lease rentals/hire-purchase instalments are past due for six months, entire dues from lease/hire should be treated as NPA. 1.3 Bills purchased/discounted bill is to be treated as NPA if it remains overdue and unpaid for six months. Overdue interest is not to be taken to income account. 1.4 Other credit facilities. All other credit facilities in nature of short-term loans/advances should be treated as NPA if any amount to be received in respect of such facility remains apse due for period of six months. 1.5 Accounting standards All accounting standards and guidance notes issued by Institute of Chartered Accountants of India (ICAI) dealing with lease accounting/ depreciation/income recognition, etc. may be followed." It is not in dispute that assessee has not provided interest income only on such account, which are classified as non-performing assets, within meaning of aforesaid criteria. 7 .1 Addition has been made relying on decision of Hon ble Supreme Court in case of State Bank of Travancore (supra). Later on, Hon ble Supreme Court in case of UCO Bank vs. CIT (supra) held same decision per inquirium and was not followed. Hon ble Supreme Court in UCO Bank case (supra) held that in accounting practice, interest, which is transferred to suspense account and not brought to P&L a/c is not treated as income. Circular of CBDT dt. 9th Oct., 1984 explains and adopts this position. circular is not contrary to provisions of s. 145 or illegal in any form. It is meant for uniform administration of law. Hon ble Supreme Court accordingly held that interest on sticky advances not brought to P&L a/c but taken to suspense account is accepted mode of treatment of notional income. Such interest has to be excluded from income till it is received. We accordingly hold that reliance on decision in case of State Bank of Travancore (supra) is misplaced on part of AO as same is subsequently not followed in case of UCO Bank (supra). Tribunal, New Delhi Bench in case of Tedco Investment & Financial Services (P) Ltd. (supra) held thus : "Sec. 45Q of RBI Act enunciates intention of legislature by stating that provisions of Chapter III-B shall have effect notwithstanding anything inconsistent therewith contained in any other law for time being in force or any instrument having effect by virtue of any such law as result of that. There is no dispute that IT Act is Act of Parliament but this fact does not detract from fact that RBI Act is also Act of Parliament. As far as issue at hand is concerned, RBI Act is special Act applicable for purposes of instant appeal to class of assessees as opposed to IT Act which is applicable to assessees at large and, thus, can be considered to be general Act. Thus, RBI Act is applicable only to special class of assessees. Accordingly, tax authorities were also not correct in coming to conclusion that IT Act is special Act and RBI Act is General Act as position for purpose of issue at hand is vice versa. RBI Act was incorporated for specific purpose and s. 45Q categorically brings out intention of legislature inasmuch as it states that Chapter IIIB shall override for all intents and purposes. Anything inconsistent with any other Act for time being in force or any instrument having effect by virtue of any such law shall fade into oblivion on account of that fact. Therefore, additions made by AO disregarding prudential norms were to be deleted." In similar issue by Tribunal, Hyderabad Bench in case of TCI Finance Ltd. vs. Asstt. CIT (supra), headnote reads as under : "Accounts-Rejection-Norms laid down by RBI in respect of non-performing assets Assessee, non-banking financial company, consistently following prudential norms prescribed by RBI in respect of income from non-performing assets and not returning such income on accrual basis, though keeping accounts on mercantile system Such method accepted by Revenue for asst. yrs. 1995-96 t o 1998-99 but not for asst. yr. 1999-2000 Said norms of RBI not inconsistent with Accounting Standard-1 notified by CBDR vide Notification No. SO 69(E) dt. 25th Jan., 1996 When Revenue could not demonstrate that consistent method of accounting followed by assessee is in violation of AS-1, same cannot be disturbed Accrual of income has to be judged from realistic point of view Addition cannot be sustained" Just like non-banking finance company is governed by provision of RBI, housing finance company is governed by NHB Act and guidelines and circular issued by NHB. Since assessee is directed not to account for such income following prudential norms, income cannot be taxed merely on basis of accrual method. Thus, income on such NPA has to be excluded while computing income under IT Act. In result, both appeals are allowed. *** CANFIN HOMES LTD. v. JOINT COMMISSIONER OF INCOME TAX