1998 (11) TMI 25 - HC - Income Tax

Summary

Issues Involved:
1. Method of accounting followed by the assessee.
2. Taxability of penal interest accrued but not collected.
3. Consistency in the method of accounting.
4. Tribunal's reliance on notes in the balance-sheet.
5. Legal precedents and their applicability.

Issue-wise Detailed Analysis:

1. Method of Accounting Followed by the Assessee:
The assessee, a company fully owned by the Government of Tamil Nadu, claimed to have shifted from the mercantile system of accounting to a hybrid system starting from the assessment year 1974-75. However, for the assessment years 1979-80 and 1980-81, it was contended that the penal interest had not been collected and thus not included in the profit and loss account. The court noted that for all previous years, the assessee had consistently followed the mercantile system of accounting.

2. Taxability of Penal Interest Accrued but Not Collected:
The Income-tax Officer added Rs. 27,87,113 and Rs. 25,04,368 for the assessment years 1979-80 and 1980-81, respectively, as the penal interest accrued on overdue instalments. The court emphasized that the taxability of income is not dependent on whether the assessee chooses to disclose it in the profit and loss account. The Supreme Court's decision in State Bank of Travancore v. CIT was cited, where it was held that interest accrued, even if not shown in the profit and loss account, must be treated as part of the income.

3. Consistency in the Method of Accounting:
The court found no evidence that the assessee had changed its accounting method from mercantile to cash system. The alleged change in the treatment of penal interest from 1974-75 was not substantiated, as for the years 1974-75 to 1978-79, penal interest was treated as accrued and taxed accordingly. The court held that the assessee's claim to treat penal interest differently for the years 1979-80 and 1980-81 was not acceptable.

4. Tribunal's Reliance on Notes in the Balance-sheet:
The Tribunal had relied on the notes in the balance-sheet which stated that penal interest had not been taken into account. However, the court held that the mere non-inclusion of penal interest in the profit and loss account does not exclude it from being part of the assessee's income, especially given the consistent use of the mercantile system.

5. Legal Precedents and Their Applicability:
The court referenced several legal precedents, including:
- State Bank of Travancore v. CIT, which supported the inclusion of accrued interest as income.
- Shiv Prasad Ram Sahai v. CIT, which held that once the mercantile system is adopted, income must be computed on an accrual basis.
- CIT v. Citibank N. A., which discussed the permissibility of a hybrid system of accounting but was found not applicable as the assessee had not demonstrated a consistent hybrid system.
- CIT v. Jayalakshmi Trading Co., which emphasized that only real income should be taxed, but did not support the assessee's inconsistent treatment of penal interest.

Conclusion:
The court concluded that the assessee had consistently followed the mercantile system of accounting and that penal interest, being of the same nature as regular interest, must be treated as accrued income. The Tribunal's decision to exclude the penal interest from taxable income was thus erroneous. The question was answered in favor of the Revenue and against the assessee.