2002 (8) TMI 30 - HC - Income Tax

Interest on Securities - 1. Whether, on the facts and circumstances of the case, the Appellate Tribunal is right in law that the interest on debentures issued by companies other than local authority, company or corporation established by a Central, State or Provincial Act is not liable to be computed as income under the head Interest on securities ? - 2. Whether interest on debentures in all circumstances is liable to be considered income only when received by the assessee and not when it becomes due? - our answer to question No. 2 is that since the assessees were adopting the cash system of accounting, interest on debentures of ASE Ltd. and Repropack (P.) Ltd., is liable to be considered as income only when received by the assessees and not when it was due for payment by the respective companies.

Issues Involved
1. Whether interest on debentures issued by companies other than those established by a Central, State, or Provincial Act is liable to be computed as income under the head "Interest on securities."
2. Whether interest on debentures is liable to be considered as income only when received by the assessee and not when it becomes due.

Detailed Analysis

Issue 1: Computation of Interest on Debentures
The court examined whether interest on debentures issued by non-Government companies should be computed as income under the head "Interest on securities." The legislative history was considered, pointing out that section 8 of the Indian Income-tax Act, 1922, included interest on debentures issued by any company, without restriction. Section 18(1)(ii) of the 1961 Act, which added public corporations established by a Central, State, or Provincial Act, did not intend to restrict the class of companies issuing securities.

The court concluded that the words "established by a Central, State or Provincial Act" only qualify "a corporation" and not "a local authority or a company." Therefore, interest on debentures issued by all companies, whether or not established by a Central, State, or Provincial Act, is liable to be computed as income under the head "Interest on securities." The court answered this question in favor of the Revenue and against the assessee.

Issue 2: Accrual vs. Receipt Basis for Interest Income
The court considered whether interest on debentures should be taxed when it becomes due or only when received by the assessee. The Revenue argued that the word "due" in section 18(1) indicates that tax liability arises when interest is legally enforceable, irrespective of actual receipt. The legislative intent was to tax interest on an accrual basis, as indicated by the shift from "receivable" in the 1922 Act to "due" in the 1961 Act.

The assessee contended that "due" and "receivable" are interchangeable and that income should only be taxed when actually received, following the cash system of accounting. They cited the Supreme Court's decision in Godhra Electricity Co. Ltd. v. CIT, which emphasized that income-tax is a levy on real income, which must materialize to be taxable.

The court found that the change from "receivable" to "due" did not create a substantial difference. It noted that under section 193, tax is deducted at source when interest is paid, not when it becomes due, supporting the cash system of accounting. The court also referred to the concept of "real income," reiterating that income must materialize to be taxable, even under the cash system of accounting.

Given that the assessees were maintaining the cash system of accounting and did not receive any interest from ASE Ltd. from the assessment year 1986-87 onwards, the court held that interest on debentures is liable to be considered as income only when received by the assessees. This conclusion was further supported by the fact that the assessees had consistently paid tax on interest actually received and had received permission from the Assessing Officer to maintain accounts on a cash basis.

The court distinguished this case from Sarabhai Chemicals P. Ltd. v. CIT, where interest was waived retrospectively after accrual. In the present case, the assessees were not related to ASE Ltd., were not involved in business transactions, and consistently followed the cash method of accounting.

Conclusion
The court ruled in favor of the assessees on the second issue, concluding that interest on debentures should be taxed only when received. Consequently, all references were disposed of, and the tax appeals were dismissed with no order as to costs.

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