2013 (9) TMI 17 - HC - Income Tax

Disallowance u/s 36(i)(iii) - Whether assessee was liable to deduction u/s 36(1)(iii), on account of interest accrued in respect of capital converted into loan for the period 1st July, 1986 to 30th June, 1987 - Held that - Profits and gain of business are computed on ordinary commercial principles. However, when there is a statutory interdict or stipulation, regardless of the ordinary commercial principles, the statute has to be followed. Section 36(1)(iii) of the Act does not help the appellant -assessee in form of any statutory interdict. There is no statutory provision that this amount should be allowed as interest accrued pursuant to the two letters dated 4th April, 1988 and 20th April, 1988 - under the ordinary principles of accountancy the two amounts were liabilities. It was only after letters dated 4th April, 1988 and 20th April, 1988, interest became payable and accrued liabilities were incurred. Interest became due and payable for the first time. Period for which interest became payable, is different and should not be confused with time/date when liability accrued. As per the ordinary principles of commercial accountancy, the said liabilities cannot be allowed as an expenditure in the earlier years. Payment of a liability is distinct from creation or accrual of the liability and under the mercantile system profits and gains of persons are computed on the basis of principle of accrual during the period for which profits and gains have to be computed. It is not material that the liability is to be discharged at a future date or by mistake or failure, no entry of the accrued liability was made in the books of accounts. An assessee will be entitled to a particular expenditure or deduction depending upon provisions of law and not on the basis of existence or absence of entries in the books, which are not conclusive. The same principle applies to accrual of income - Following decision of Additional Commissioner of Income Tax, Delhi-II versus Rattan Chand Kapoor 1984 (2) TMI 60 - DELHI High Court - Decided against assessee.

Summary

Issues Involved:
1. Deductibility of Rs.1,88,17,168/- under Section 36(1)(iii) of the Income Tax Act for interest accrued on capital converted into a loan for the period 1st July, 1986 to 30th June, 1987.
2. Deductibility of Rs.62,66,667/- under Section 36(1)(iii) of the Income Tax Act for interest accrued on capital converted into a loan for the period 1st April, 1986 to 30th June, 1986.

Detailed Analysis:

Issue 1: Deductibility of Rs.1,88,17,168/- under Section 36(1)(iii) for the period 1st July, 1986 to 30th June, 1987

The appellant, a multi-State Cooperative Society, argued for the deduction of Rs.1,88,17,168/- as interest accrued on capital converted into a loan. The conversion of capital into loan was based on letters dated 4th April, 1988 and 20th April, 1988 from the Government of India. The Assessing Officer rejected the claim, stating that the liability had not accrued during the relevant previous years but only after the issuance of the letters. The tribunal upheld this view, asserting that the interest liability could only be claimed in the period relevant to the assessment year when the letters were issued.

The court emphasized that under the mercantile system of accounting, both accrued credits and liabilities must be considered. However, the conversion of equity into a loan and the consequent interest liability did not accrue during the relevant assessment years but only after the letters were issued. The court noted that prior to the letters, there was no indication or possibility of such a liability arising. Thus, the liability crystallized only after the end of the previous years in question, making the interest non-deductible for those periods.

Issue 2: Deductibility of Rs.62,66,667/- under Section 36(1)(iii) for the period 1st April, 1986 to 30th June, 1986

Similar to the first issue, the appellant claimed a deduction for Rs.62,66,667/- as interest accrued on capital converted into a loan. The tribunal, following the same reasoning as in the first issue, denied the deduction, stating that the liability accrued only after the letters dated 4th April, 1988 and 20th April, 1988 were issued.

The court reiterated that the appellant was following a mercantile system of accounting, where liabilities must be accounted for when they accrue. The court distinguished between contractual and statutory liabilities, noting that the present case involved a contractual liability that only became due after the letters were issued. The court concluded that since the liability to pay interest did not exist during the relevant assessment years, the deduction could not be allowed.

Conclusion:

The court concluded that the interest liabilities claimed by the appellant had not accrued during the relevant assessment years but only after the letters from the Government of India were issued. As a result, the deductions under Section 36(1)(iii) for the amounts of Rs.1,88,17,168/- and Rs.62,66,667/- were not permissible for the assessment years in question. The appeals were dismissed, with the questions of law answered in favor of the respondent-Revenue and against the appellant-assessee. No order as to costs was made.