2006 (10) TMI 134 - HC - Income Tax

Allegation on assessee is that he is following cash system for interest and mercantile system for others it cannot be said that it was impermissible for the assessee to have followed a mixed or a hybrid system of accounting assessee could not be held to be disentitled to change the method of accounting on the ground that such a mixed system of accounting would result in loss to Revenue for that year - Tribunal was right in holding that interest should be taxed only on cash basis

Issues:
1. Application of cash system of accounting for interest income.
2. Permissibility of hybrid accounting system.

Issue 1: Application of cash system of accounting for interest income

The judgment pertains to an appeal against the order of the Income-tax Appellate Tribunal concerning the assessment year 1993-94. The appellant, a company owned by the State Government, initially admitted an income of Rs. 49,40,823 for the said year. Subsequently, a notice under section 148 of the Income-tax Act was issued as some income had escaped assessment. The Assessing Officer noted that while the appellant followed the mercantile system of accounting, it applied the cash system only for interest received from M/s. Andhra Bank Financial Services Ltd. The Assessing Officer treated the interest accrued during the relevant period as income on the mercantile basis.

Upon appeal, the Commissioner of Income-tax (Appeals) upheld the addition of Rs. 40 lakhs as interest accrued and receivable from M/s. Andhra Bank Financial Services Ltd. for the assessment year 1993-94. However, the Tribunal, considering previous orders and relevant case law, held that the appellant was entitled to follow the cash system of accounting for interest income. The Tribunal set aside the orders of the lower authorities and upheld the appellant's claim. The Department raised substantial questions of law challenging the Tribunal's decision.

The main argument put forth by the Revenue was that since M/s. Andhra Bank Financial Services Ltd. agreed to pay interest only after settling the principal amount, it should be considered that the interest was actually received by the appellant. On the other hand, the appellant contended that the interest did not accrue as the principal was in doubt, and the bank defaulted in payment during a previous financial year, leading the appellant to account for interest on a receipt basis.

Issue 2: Permissibility of hybrid accounting system

The judgment also delves into the permissibility of a hybrid accounting system, referencing the decision in UCO Bank v. CIT [1999] 237 ITR 889. In the UCO Bank case, the apex court approved a mixed system of accounting where income from doubtful loans was considered real income only upon realization, despite following the mercantile system. Subsequently, in CIT v. Pondicherry Industrial Promotion Development Investment Corporation Ltd. [2002] 254 ITR 748, this court reiterated the permissibility of a mixed or hybrid accounting system. The court held that while following the mercantile system, adopting a cash system for interest and rent was acceptable. It was emphasized that a genuine change in the accounting method, even if resulting in a loss to the Revenue for that year, should not disentitle the assessee from such a modification.

The judgment concluded that the principles established in the aforementioned cases were directly applicable to the facts of the present case. Consequently, the court found no substantial question of law and dismissed the appeal, affirming the appellant's entitlement to follow the cash system of accounting for interest income.

This detailed analysis of the judgment highlights the issues of applying the cash system of accounting for interest income and the permissibility of a hybrid accounting system, providing a comprehensive overview of the legal reasoning and decisions involved in the case.

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