Non-Ba Banking nking Finance ance Compa panies nies Tax x Aspect ects 26 September mber 2014
Contents Non-Banking Finance Company (NBFC) – An Overview ► Tax Aspects ► Page 2
NBFCs - An Overview
NBFCs – An Overview Reserve Bank of India Non-Banking Financial Companies Deposit taking Non Deposit taking CIC NBFC-ND-SI NBFC-ND (Asset size >= Rs 100 CR) Infrastructure Investment Asset Finance Loan Finance Page 4
What is NBFC? NBFC has been defined under Section 45-I(f) of the RBI Act: „„non - banking financial company‟‟ means– ► a financial institution which is a company; a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify. Section 45-I(e): „„non - banking institution‟‟ means a company, corporation or cooperative society ► Page 5
Financial Institution Section 45-I(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: – financing business acquisition of securities hire-purchase business insurance business chit fund business collecting/ disbursement of money, awarding prizes or gifts, etc Exceptions: If the principal business of the institution includes ► agricultural operations; industrial activity; purchase/ sale of any goods (other than securities) or providing services; or purchase, construction or sale of immovable property, so however, that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons Page 6
Principal Business The company will be treated as a non-banking financial company (NBFC) if its financial ► assets are more than 50 per cent of its total assets (netted off by intangible assets) and income from financial assets is more than 50 per cent of the gross income. Both these tests are required to be satisfied as the determinant factor for principal business of a company - Press Release 1998-99/1269 dated April 8, 1999 Page 7
NBFCs – Key Terms Infrastructure Finance Company NBFC which deploys atleast 75% of its total assets in infrastructure loans ► Additional requirements ► Shall not accept deposits from public ► Shall have net-owned funds of Rs 300 crores or above ► Shall have a minimum credit rating “A” or equivalent of CRISIL, FITCH, CARE, ICRA or other accrediting rating ► agencies ► Shall have a CRAR of 15% (with a minimum Tier I capital of 10%) Infrastructure loan means a credit facility by way of term / project loan, subscription to bonds / debentures / preference shares / equity shares in a project company engaged in infrastructure facility in any of the following sectors Road, bridge, rail system; ► ► Highway project; Port, airport, inland waterway / port; ► Water supply project, irrigation project, etc; ► ► Telecommunication / internet services; Industrial park / SEZ; ► Power; etc. ► Page 8
Tax Aspects
NB NBFC C – Key tax aspects pects Interest on Non-performing Assets (NPAs) ► Receipt of additional finance charges (AFC) ► Matching concept ► Provision created in respect of NPAs ► Disallowance of expenses under section 14A of the Income-tax Act, 1961 (Act) ► ► Income earned from a securitization trust Finance Lease ► Mark-to-market loss incurred on account of trading in derivative instruments ► Bad debts written off in the books of account ► TDS under section 194A of the Act ► Page 10
Int nter erest est on on N NPAs As per the guidelines issued by the Reserve Bank of India (RBI) on recognition of income on loans, ► interest income on NPAs is required to be recognised on a receipt/ realisation basis Further as per AS 9 where the ability to assess the ultimate collection with reasonable certainty is ► lacking at the time of raising any claim, eg. for escalation of price, export incentives, interest etc., revenue recognition is required to be postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognize revenue only when it is reasonably certain that the ultimate collection will be made As per Section 43D, in case of Public financial institution, Scheduled Bank and State Financial ► Corporation and such other prescribed entities, the interest in relation to Non performing Assets shall be chargeable to tax in the previous year in which it is credited to the profit and loss account or year in which it is actually received, whichever is earlier As seen earlier, NBFCs are „financial institutions‟, hence even in case of NBFCs following ► mercantile basis of accounting, all interest income would be recognised on an accrual basis except for accrual of interest on NPAs However, the Supreme Court in the case of Southern Technologies [2010] (228 CTR 440) ► interest from NPAs is taxable on due basis on the basis that the RBI guidelines for non-recognition of interest income are merely disclosure norms and they are not in any way connected to computation of total income under the Act. Further, the Supreme Court also observed that the provisions of section 43D of the Act do not apply to NBFCs on the basis that NBFC s and banks are functionally different Page 11
Int nter erest est on on N NPAs ► Various Courts/ Tribunals have held that (prior to the Supreme Court ruling in the case of Southern Technologies) the question of accrual can be considered only after recognizing income from such assets In this regard, the Supreme Court in the case of UCO Bank [1999] (237 ITR 889) has held that if the ► loan given by the assessee is itself doubtful of recovery, the illusory interest thereon of which recovery is beyond hope cannot be brought to tax year after year on the ground of accrual In the case of Tedco Investment & Finance Services P. Ltd. v. DCIT [2004] (82 TTJ 259) , the Delhi ► ITAT held that income under mercantile system of accounting could be recognised only subject to the prudential norms issued by RBI which are to be followed by an NBFC The Delhi High Court in the case of CIT v. Vasisth Chay Vyapar [2010] (238 CTR 142) distinguished ► the ruling of the Supreme Court in the case of Southern Technologies Ltd and held that: “U/s 45Q of the RBI Act read with the NBFCs Prudential Norms (Reserve Bank) Directions 1998, it was mandatory on the part of the assessee not to recognize the interest on the ICD as it had become a NPA. The assessee was bound to compute income having regard to the recognized accounting principles set out in Accounting Standard AS-9. AS-9 provides that if there are uncertainties as to recognition of revenue, the revenue should not be recognized. Accordingly, the argument of the revenue that the interest on the NPA can be said to have accrued despite it being a NPA is not acceptable.” Page 12
Int nter erest est on on N NPAs In the case of CIT v. Motor Credit Co. P. Ltd. [1981] (127 ITR 572) , the Madras High Court held ► that: “Where no income has resulted it cannot be said that income has accrued merely on the ground that the assessee had been following mercantile system of accounting. Even if the assessee makes a debit entry to that effect, still no income can be said to have accrued to the assessee. If no income has materialized, there can be no liability to tax on a hypothetical income. It is not the hypothetical accrual of income based on the mercantile system of accounting followed by the assessee that has to be taken into account, but what should be considered is whether the income has really materialized or resulted to the assessee. The question whether real income has materialized to the assessee has to be considered with reference to commercial and business realities of the situation in which the assessee has been placed and not with reference to his system of accounting.” Based on the above jurisprudence, a view could be taken that if no “real” income is recognized at ► all from such assets, there is no question of applying the principle of accrual. Accordingly, the interest from NPAs should be taxed in the appropriate assessment years on the basis of actual receipt Page 13
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