1996 (11) TMI 101 - AT - Income Tax

Assessing Officer, Assessment Year, Bad Debt, Bona Fide, Change In Method, Mercantile System, Previous Year, Total Income, Write Off

Issues Involved:
1. Change in the method of accounting from mercantile to cash basis.
2. Accrual of interest income.
3. Applicability of the principle of real income.
4. Deduction of bad debts under section 36(1)(vii) of the Income Tax Act.

Analysis:

1. Change in the method of accounting from mercantile to cash basis:

The assessee-company, which was following the mercantile system of accounting, decided to change its method of accounting for interest on loans to a cash basis for certain debtors from whom interest had not been received for a long time. This change was formalized through a resolution passed in the Annual General Meeting on 21-12-1988. However, the Assessing Officer did not accept this change, stating that it was not an approved method and was not systematically applied to all loans. The first appellate authority upheld this view, stating that the change was not an acceptable systematic method.

2. Accrual of interest income:

The assessee did not account for interest accrued from 1-7-1988 to 31-3-1989 in its books of account, claiming it as bad debt written off. The Assessing Officer rejected this, stating that the interest of Rs. 1,20,750 accrued up to 30-6-1988 could not be written off as bad debt since no decision was taken under the resolution to write off the same. Additionally, an amount of Rs. 90,564, representing interest accrued from 1-7-1988 to 31-3-1989, was added back to the income.

3. Applicability of the principle of real income:

The principle of real income was debated extensively. The assessee argued that since the principal amount itself was doubtful of recovery, the interest income should not be considered as accrued. The assessee relied on several judicial precedents to support this view. However, the revenue contended that once income accrues based on the method of accounting followed, it remains taxable, and mere giving up of interest does not convert accrual into non-accrual. The Tribunal, referencing the majority decision in the State Bank of Travancore case, held that mere improbability of recovery does not negate the accrual of income, and the concept of real income must be applied with care and within well-recognized limits.

4. Deduction of bad debts under section 36(1)(vii) of the Income Tax Act:

The first appellate authority allowed the deduction of Rs. 1,20,750 as bad debt under section 36(1)(vii), as it was taken into account as income in the previous year. However, the addition of Rs. 90,564 was confirmed. The Tribunal noted that post-1989, the requirement to establish that the debt had become bad in the previous year was removed, and the only pre-condition was that the debt should have been taken into account in computing the income. Given that the interest income was accrued and the principal amounts were not recovered, the Tribunal held that both amounts (Rs. 1,20,750 and Rs. 90,564) should be allowed as deductions under section 36(1)(vii).

Conclusion:

The Tribunal concluded that the interest income had accrued to the assessee under the mercantile system of accounting. However, considering the facts and circumstances, including the non-recovery of the principal amounts and the subsequent non-addition of interest income by the Assessing Officer in later years, the Tribunal allowed both amounts (Rs. 1,20,750 and Rs. 90,564) as deductions under section 36(1)(vii) of the Income Tax Act. The appeal filed by the assessee was allowed, and the appeal by the revenue was dismissed.

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