2020 (11) TMI 180 - HC - Income Tax

Accrual of income - Revenue recognition - real or hypothetical income - addition on account of wheeling charges - assessee is following mercantile system of accounting - HELD THAT - The Karnataka Electricity Board which owned transmission lines in Karnataka decided to recover wheeling charges from State Electricity Board's of Tamil Nadu, Andhra Pradesh and Kerala to the tune of ₹ 52.89 Crores. The assessee therefore, did not raise any demand on account of wheeling charges and since, there was uncertainty with regard to recovery / collection of the outstanding amount, the assessee for the AY in question decided not to recognize revenue of ₹ 52.89 Crores for wheeling charges. In the meeting held on 04.11.2000 and the same was approved by the board of the assessee. Aforesaid income never accrued to the assessee and was in fact, an hypothetical income and not a real income. Subsequently, on 16.03.2004 in 134th meeting of Southern Regional Electricity Board, the arrangement of cost sharing of wheeling charges by the constituent States itself was scrapped and on the date when the Assessing Officer passed an order i.e., on 31.12.2008, the aforesaid decision was already in existence. Income did not accrue to the assessee but was a hypothetical income, which could not have been subjected to tax and in view of Accounting Standard-9, the assessee rightly decided not to recognize the revenue of ₹ 52.89 Crores for wheeling charges for the relevant assessment year. - Decided in favour of the assessee

Summary

Issues:
1. Whether wheeling charges accrued but not realized are liable to tax under the mercantile system of accounting?
2. Whether the assessee correctly applied the mercantile system of accounting in recognizing revenue for wheeling charges?

Analysis:

Issue 1:
The appeal involved the question of whether wheeling charges accrued but not realized are taxable under the mercantile system of accounting. The Karnataka State Government undertaking, engaged in electricity transmission, declared a loss in the Assessment Year 2001-02. The Assessing Officer added &8377; 52.89 Crores as wheeling charges to the income of the assessee, contending that under the mercantile system, income accrues when the right to receive is recognized, irrespective of actual receipt. The Commissioner upheld this addition. However, the Tribunal found that the uncertainty of recovering the charges led the assessee to not recognize the income, as it would distort profits. The Tribunal noted the lack of expenditure debited for transmission and the absence of demands for wheeling charges in subsequent years. It concluded that the income did not accrue, being hypothetical and not real. The High Court affirmed this view, emphasizing that under Accounting Standard-9, the revenue was rightly not recognized, dismissing the revenue's appeal.

Issue 2:
The second issue revolved around whether the assessee correctly applied the mercantile system of accounting in recognizing revenue for wheeling charges. The revenue argued that once the right to receive income is recognized, it accrues and is taxable, citing relevant case law. However, the assessee contended that under the mercantile system, revenue accrual requires reasonable certainty of collection. Referring to Accounting Standard-9 and Supreme Court decisions, the assessee maintained that only real income can be taxed, not hypothetical income. The High Court agreed with the assessee, noting that the income in question was hypothetical, not real, and correctly not recognized under the mercantile system. The Court dismissed the appeal, ruling in favor of the assessee based on the application of the mercantile system of accounting and relevant legal principles.

In conclusion, the High Court upheld the Tribunal's decision, emphasizing the correct application of the mercantile system of accounting and the distinction between real and hypothetical income in determining tax liability.