1986 (1) TMI 131 - AT - Income Tax

Method Of Accounting, Charitable Or Religious Trust, Exemption Of Income From House Property Held Under

Summary

Issues Involved:
1. Taxability of Interest from Banarasidas Ramgopal
2. Method of Accounting Followed by the Assessee
3. Applicability of Section 13(1)(c) and Section 13(2)(a) of the Income-tax Act, 1961
4. Adequacy of Security and Interest for Loans

Issue-wise Detailed Analysis:

1. Taxability of Interest from Banarasidas Ramgopal:
The primary issue was whether the interest from Banarasidas Ramgopal should be taxed on an accrual basis or a receipt basis. The assessee contended that it followed the cash system of accounting and thus, the interest should be taxed only when actually received. The Tribunal noted that the interest was credited to the assessee's account by Banarasidas Ramgopal but was not received in cash until 1979. The Tribunal concluded that the interest could only be taxed on a receipt basis, aligning with the cash system of accounting followed by the assessee.

2. Method of Accounting Followed by the Assessee:
The Tribunal examined whether the assessee followed the cash or mercantile system of accounting. The assessee argued that the interest on fixed deposits was deemed received in cash due to standing instructions to the bank to convert matured interest into fresh deposits. The Tribunal accepted this argument, stating that the conversion of interest into a new fixed deposit receipt amounted to actual payment. Thus, the assessee was found to be following the cash system of accounting, and the interest from Banarasidas Ramgopal could not be taxed on an accrual basis.

3. Applicability of Section 13(1)(c) and Section 13(2)(a) of the Income-tax Act, 1961:
The assessee, a charitable trust, claimed exemption under Section 11. However, the ITO and AAC denied this exemption, invoking Section 13(1)(c), which disallows exemption if any part of the income or property of the trust is used for the benefit of specified persons. The ITO argued that the funds were used for the benefit of Shri S.K. Vaid, a trustee and partner in Banarasidas Ramgopal. The Tribunal upheld this view, noting that the funds were lent to a concern in which a trustee was interested, thus falling under Section 13(1)(c).

4. Adequacy of Security and Interest for Loans:
The Tribunal examined whether the loan to Banarasidas Ramgopal was backed by adequate security and interest as required by Section 13(2)(a). The assessee argued that the loan was adequately secured by a floating charge on the firm's assets and personal bonds from partners. However, the Tribunal found that a floating charge and personal bonds did not constitute adequate security. Although the interest rate of 15% was deemed adequate, the lack of adequate security meant the loan did not meet the requirements of Section 13(2)(a). Consequently, the provisions of Section 13(1)(c)(ii) were applicable, and the assessee was not entitled to exemption under Section 11.

Conclusion:
The appeals were partly allowed. The interest from Banarasidas Ramgopal was to be taxed on a receipt basis, adhering to the cash system of accounting followed by the assessee. However, the exemption under Section 11 was denied due to the application of Section 13(1)(c) and Section 13(2)(a), as the loan was not backed by adequate security, even though it carried adequate interest.