2011 (1) TMI 761 - HC - Income Tax

Accrued interest - The assessee/appellant before the accounting year ended 31st March 1988 granted loan to one M/s. Swan Mills Industries. The said loan amount was repayable however the same was not paid - Therefore there has been accrual of interest on the said loan amounting to Rs. 16, 27, 059 even though the assessee company did not reflect it in the profit and loss account - The question is arise whether the amount of interest accrued on the loan should be included in the assessment as being an income despite the fact that the BIFR had sanctioned a scheme under the Sick Industrial Companies (Special Provision) Act 1985 (in short SICA) and further after approval of the Board of Directors of the assessee company for not showing the said income of interest amount in the profit and loss account - Since date of referring the said SML to BIFR and further scheme having been framed and particularly when the said interest income has not been shown in the accounts at all it cannot be said that income has accrued for the purpose of taxation - Accordingly allow the appeal and direct the Assessing Officer to exclude the interest income on the said loan as it has become sticky from the previous accounting year that is 1989-90 and also subsequent years - Decided in favour of assessee.

Issues Involved:
1. Approval of non-charging of interest by the Board of Directors.
2. Relation back of the Board's approval to the accounting year.
3. Accrual of interest under the Sick Industrial Companies (Special Provisions) Act, 1985.
4. Sustainability of inclusion of interest on loans and advances as income.

Issue-wise Detailed Analysis:

1. Approval of Non-Charging of Interest by the Board of Directors:
The court examined whether the approval made by the Board of Directors concerning the balance-sheet and profit and loss account, which indicated non-charging of interest on the loan to Swan Mills Limited, legally implied the Board's approval of non-charging of interest. The appellant argued that the Board's resolution for finalizing the accounts occurred after the financial year, implying a retrospective effect from the beginning of the year. The court noted that the Board's approval of the accounts should be considered conclusive unless questioned by the department, and that the income must be real and not hypothetical for tax purposes.

2. Relation Back of the Board's Approval to the Accounting Year:
The court deliberated whether the approval of the Board of Directors of the accounts, including the balance-sheet and profit and loss account, should relate back to the accounting year in question. The appellant contended that once the Board adopts the correctness of any accounts, it should have retrospective effect from the beginning of the accounting year. The court supported this view, indicating that the approval of the accounts by the Board should be considered effective from the start of the accounting year.

3. Accrual of Interest Under the Sick Industrial Companies (Special Provisions) Act, 1985:
The court analyzed whether the interest on advances/loans made to Swan Mills Limited could be considered accrued and included in the assessee's income, given the provisions of the Sick Industrial Companies (Special Provisions) Act, 1985, and the scheme framed by the Board of Directors. The court noted that under Section 22 of SICA, neither the principal amount nor the interest could be recovered from the date of making a reference without the Board's consent. It was established that the loan had become sticky due to the impossibility of recovery, and the interest income was not shown in the profit and loss account, thus it could not be taxed.

4. Sustainability of Inclusion of Interest on Loans and Advances as Income:
The court considered whether the inclusion of interest on loans and advances to Swan Mills Limited was sustainable in law or otherwise unreasonable and perverse. The appellant argued that the interest did not form part of the real income since it was never realized. The court agreed, referencing several Supreme Court decisions that supported the notion that hypothetical income, which does not materialize, cannot be taxed. The court concluded that since the interest income had not been shown in the accounts and the loan had become irrecoverable, it could not be considered as accrued income for taxation purposes.

Conclusion:
The court allowed the appeal, directing the Assessing Officer to exclude the interest income on the loan to Swan Mills Limited from the previous accounting year 1989-90 and subsequent years, as it had become sticky and was not shown in the accounts. The decision was based on the principle that income must be real and not hypothetical for tax purposes, and the Board's approval of the accounts should be considered effective from the start of the accounting year.

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