2008 (3) TMI 715 - AT - Income Tax

Taxability of income - Mercantile System of Accounting - In the year the assessee got the right to receive the income or the year of accrual as per the system of accounting followed by the assessee - interest payable under ss. 234B and 234C - HELD THAT - We conclude that payment of royalty to the assessee by GGL was fixed by the IDBI, for which assessee had also consented, and the same was dependent on the terms and conditions of no overdue debt to the financial institution and there being availability of sufficient cash flow in the hands of GGL, at the time of payment of instalment, can be considered as sufficient riders for postponing the assessee's rights to receive the royalty and the same was to be received only when GGL was having sufficient cash flow and no overdue to any financial institution. Both these conditions could be complied only at the time of payment of instalments of royalty and prior to the said date there existed uncertainty as to the ultimate payment of the royalty amount. Therefore, notwithstanding the mercantile system of accounting being followed by the assessee, royalty income accrued in favour of assessee only in the years the right to receive such royalty income accrued in favour of assessee as per the terms of consent letter. Accordingly, royalty accrued in favour of the assessee in the AY 2003-04 and AY 2004-05. As the assessee was in receipt of royalty of from GGL for the period 1st April, 1993 to 31st March, 1995 during the relevant assessment year under consideration, the same is liable to be taxed accordingly in the AY 2002-03 under consideration. We direct accordingly. Charging of interest under ss. 234B and 234C is consequential in nature, the AO is directed to give due credit for the TDS pertaining to the income received by the assessee and recompute the interest chargeable under ss. 234B and 234C of the Act. In the result, the appeal of the assessee is allowed in terms indicated hereinabove.

Issues Involved:
1. Year of Taxability of Income
2. Accrual of Royalty Income
3. Application of Mercantile System of Accounting
4. Conditions imposed by IDBI
5. Right to Receive Income
6. Charging of Interest under Sections 234B and 234C

Detailed Analysis:

1. Year of Taxability of Income:
The primary issue in this appeal was to determine whether the income should be taxed in the year the assessee got the right to receive it or in the year of accrual as per the accounting system followed by the assessee. The assessee entered into a technical license agreement with M/s Gujarat Guardian Ltd. (GGL) and was supposed to receive royalty from 1st March 1993 to 28th February 2001. However, due to conditions imposed by IDBI, GGL could not pay any royalty until 31st March 1999. IDBI later allowed payments from 1st April 1999 to 28th February 2001 and approved past unpaid royalty payments in installments from 1st October 2001 to 1st April 2004, subject to certain conditions.

2. Accrual of Royalty Income:
The approval letter dated 26th April 2001 from IDBI did not confer absolute rights to the assessee to receive royalty income, as it was subject to the availability of adequate cash flow and no overdue payments by GGL. The Assessing Officer (AO) brought the entire royalty income of Rs. 21.53 crores to tax in the relevant previous year, considering the approval letter as the accrual point. However, the Tribunal held that income accrues when the assessee gets the right to receive it, not merely based on the approval letter.

3. Application of Mercantile System of Accounting:
The assessee followed the mercantile system of accounting. The Tribunal emphasized that income for which the assessee does not get the right to receive due to certain terms and conditions cannot be brought to tax merely because of the accounting method followed. As per Accounting Standard (AS 9) on revenue recognition, revenue is recognized only when it is reasonable to expect the ultimate collection.

4. Conditions imposed by IDBI:
The Tribunal observed that due to IDBI's restrictions, the royalty income did not accrue to the assessee in the relevant previous year. The conditions laid down by IDBI for the realization of royalty meant that the income became due only when GGL complied with these conditions. Therefore, the royalty income of Rs. 10.17 crores for the period 1st April 1995 to 31st March 1997 became due during the financial year ending on 31st March 2003, and Rs. 11.96 crores for the period 1st April 1997 to 31st March 1999 became due during the financial year ending on 31st March 2004.

5. Right to Receive Income:
The Tribunal held that income accrues when the assessee acquires the right to receive it. In this case, the right to receive royalty income was contingent upon IDBI's conditions being met. Therefore, the income could not be brought to tax until these conditions were satisfied. The Tribunal cited the case of E.D. Sassoon & Co. Ltd. vs. CIT, where the Supreme Court held that income accrues only when there is a right to receive it.

6. Charging of Interest under Sections 234B and 234C:
The Tribunal directed the AO to give due credit for the TDS pertaining to the income of Rs. 5.98 crores received by the assessee and recompute the interest chargeable under Sections 234B and 234C of the Act. The charging of interest under these sections is consequential in nature.

Conclusion:
The Tribunal concluded that the royalty income accrued to the assessee only in the years when the right to receive it was established as per IDBI's conditions. Accordingly, the royalty of Rs. 10.17 crores accrued in the assessment year 2003-04 and Rs. 11.96 crores in the assessment year 2004-05. The income of Rs. 5.98 crores received during the relevant assessment year 2002-03 was liable to be taxed accordingly. The appeal of the assessee was allowed in these terms.

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