The finance ministry is likely to extend the favourable tax treatment currently given to banks, public financial institutions and state finance corporations on their income from non-performing assets (NPAs) to non-banking financial companies (NBFCs) as well, making them taxable only in the year of receipt.
At present, NBFCs are taxed on such income in the year of accrual, while banks, PFIs, state finance corporations, housing finance companies and state industrial investment corporations are taxed only when it is received or credited to the profit and loss account, whichever is earlier.
Sources said the department of financial services and the banking regulator have favoured the extension of the accounting benefit under Section 43D of the Income Tax Act to NBFCs too at pre-budget consultations within the finance ministry. NBFCs are bank-like institutions with the exception that these do not offer savings accounts.
Like other lenders, NBFCs too follow the Reserve Bank of India’s (RBI’s) prudential norms and defer income regarding their NPAs and make provisions for the same. However, income tax authorities do not recognise these norms and tax NBFCs on such deferment of income on accrual basis resulting in tax on unrealised income.
Sources in the department of financial services said the government is “positively inclined” to offer tax parity to NBFCs and the other lenders describing it a “reasonable demand” and hinted that the Budget could announce this change. The issue came up for discussion during a meeting in Mumbai on February 9 between industry representatives and officials including finance minister P Chidambaram, and senior officials from the department of financial services and the RBI.
“The tax authorities must accept this principle of income deferral also for NBFCs registered with RBI. NBFC is the only segment of the financial sector which is denied this tax benefit,” Raman Aggarwal, director (member, managing committee), Finance Industry Development Council (a self-regulatory organisation for asset financing NBFCs) and senior vice-president, Srei Equipment Finance, said.
According to Fitch India Rating, the gross NPAs of NBFCs may grow from 1.9% to 3 % of their gross advances in the next 12-18 months and provisioning for these will grow to Rs 345 crore in the same period from the current Rs 172 crore, the report said.
Sunil Chandiramani, partner, Ernst & Young said while bad loans of NBFCs are on the rise, these entities are taking efforts to improve their asset quality. “NBFCs are now putting in place sophisticated credit rating mechanisms and are becoming much more active on their collection cycles. But they are equally susceptible to what you would see on the banking side,” said Chandiramani.
Recently, the RBI working group on NBFCs led by former RBI deputy governor Usha Thorat had also mooted tax parity between NBFCs and banks by closing the regulatory arbitrage between banks and NBFCs. “Suitable income tax deduction akin to banks may be allowed for provisions made under the regulations. Accounting norms applicable to banks may be applied to NBFCs,” the working group said.
Another disadvantage suffered by the NBFCs are regarding provision for NPAs under Section 36(1)(vii a) of the Income Tax Act.
Under this Section, provisions for bad and doubtful debts made by banks are granted deduction of 7.5% from the gross total income and 10% of aggregate average rural advances made by them. Alternatively, the banks also have an option to claim a deduction of 10% (up from the earlier 5%) on any provision made for assets classified by the RBI as doubtful / loss assets. However, this benefits is not given to NBFCs. Sources said the finance ministry is examining if parity could be accorded to NBFCs on this front too.
A finance ministry panel on NBFCs has also recommended tax parity to both banks and NBFCs on both taxation of income from NPAs in the year of receipt and on deductions under Section 36(1)(viia).