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In reply, the Department contended before us that the IT Act is a separate code by itself; that the taxable total income 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 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 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 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 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. 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 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 can accept deposits. According to the Department, vide RBI Directions 1998, RBI tries to bring out the Profit in the P&L 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 "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

According to the Department, under the accounting 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, 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 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 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 45Q of the RBI Act). Therefore, according to the Department, inconsistency in terms of Section 45Q of the RBI Act is only with respect to the Companies 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 that Section 45Q 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 intention of Section 45Q of the IT Act. That, the said 1998 Directions cannot be taken as an excuse by the NBFC to compute lower taxable income under the IT Act.

It needs to be emphasized that the said 1998 Directions are only Disclosure Norms. They have nothing to do with computation of Total Taxable Income under the IT Act or with the accounting treatment. The said 1998 Directions only lay down the manner of presentation of NPA provision in the balance sheet of an NBFC.

Analysis of Para 9 of RBI Directions 1998 Vide Para 9, RBI has mandated that every NBFC shall disclose in its Balance Sheet the Provision without netting them from the Income or from the value of the assets and that the provision shall 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 such provision for each year shall 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 Loss on assets classified as NPA. An NPA continues to be an Asset - "Debtors/ Loans and Advances" in the books of NBFC. For creating a provision the only yardstick is default in terms of the loan under RBI norms, a provision is mathematical calculation on time lines. 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 accounting concepts.

Prior to RBI Directions 1998, Advances were stated net of provisions for NPAs / bad and doubtful debts. They were shown at net figure (Advances less Provisions for NPAs) and the amount of provision for NPA was shown in the notes to the accounts only. Such presentation of NPA Provision warranted disclosure. Therefore, Para 9(1) of RBI Directions 1998 stipulates that every NBFC shall separately disclose in its Balance Sheet the provision for NPAs without netting them from the income or against the value of assets. That, the provision for NPA should be shown separately on the "Liabilities side" of the Balance Sheet under the head "Current Liabilities and Provisions" and not as a deduction from "Sundry Debtors/ Advances". Therefore, RBI has taken a position as a matter of disclosure, with which we agree, that if an NBFC deducts a provision for NPA from "sundry debtors/ loans and advances", it would amount to netting from the value of assets which would constitute breach of Para 9 of RBI Directions 1998. Consequently, NPA provisions should be presented on the "Liabilities side" of the Balance Sheet under the head "Current Liabilities and Provisions" as a Disclosure Norm and not as accounting or computation of income norm under the IT Act. At this stage, we may clarify that the entire thrust of RBI Directions 1998 is on presentation of NPA provision in the Balance Sheet of an NBFC. Presentation/ disclosure is different from computation/ taxability of the provision for NPA. The nature of expenditure under the IT Act cannot be conclusively determined by the manner in which accounts are presented in terms of 1998 Directions. There are cases where on facts courts have taken the view that the so-called provision is in effect a write off. Therefore, in our view, RBI Directions 1998, though deviate from accounting practice as provided in the Companies Act, do not override the provisions of the IT Act. Some companies, for example, treat write offs or expenses or liabilities as contingent liabilities. For example, there are companies which do not recognize mark-to-market loss on its derivative contracts either by creating reserve as suggested by ICAI or by charging the same to the P&L Account in terms of Accounting Standards. Consequently, their profits and reserves and surplus of the year are projected on the higher side. Consequently, such losses are not accounted in the books, at the highest, they are merely disclosed as contingent liability in the Notes to Accounts. The point which we would like to make is whether such losses are contingent or actual cannot be decided only on the basis of presentation. Such presentation will not bind the authority under the IT Act. Ultimately, the nature of transaction has to be examined. In each case, the authority has to examine the nature of expense/ loss. Such examination and finding thereon will not depend upon presentation of expense/ loss in the financial statements of the NBFC in terms of the 1998 Directions. Therefore, in our view, the RBI Directions 1998 and the IT Act operate in different fields.