1984 (3) TMI 139 - AT - Income Tax

Summary

Issues Involved:
1. Whether the AAC erred in deleting Rs. 21,500 added by the ITO in respect of the interest on a loan advanced by the assessee.
2. Whether the assessee maintained a cash system of accounting for the loan transaction.
3. Whether the interest on the loan should be considered as part of the taxable income of the assessee.

Detailed Analysis:

1. Deletion of Rs. 21,500 by AAC:
The primary issue in this appeal is that the AAC deleted Rs. 21,500, which the ITO had added to the assessee's income as interest on a loan advanced to MPD Productions. The ITO observed that the assessee, maintaining a mercantile system of accounting, did not charge interest on the loan despite an agreement stipulating a 2% interest rate. The AAC, however, found merit in the assessee's argument that the principal loan amount was in jeopardy and thus the interest was not realized or shown in the accounts.

2. Method of Accounting:
The assessee argued before the AAC that it maintained a cash system of accounting for the loan transaction, contrary to the mercantile system followed for other incomes. The AAC accepted this argument, noting that the choice of accounting method lies with the assessee, and the department is bound by this choice. The AAC cited various decisions to support this view, including B.C.G.A (Punjab) Ltd. v. CIT and CIT/EPT v. Chari & Ram. However, the revenue contended that the assessee had consistently followed the mercantile system and only claimed to follow the cash system for the loan transaction without any supporting evidence.

3. Taxability of Interest:
The AAC concluded that since the principal loan amount was doubtful of recovery, the unrealized interest should not be treated as income for the year under consideration. The AAC noted that the assessee took legal steps to recover the principal amount, indicating doubt about its realization. Therefore, the AAC opined that the interest of Rs. 21,500 should not be included in the taxable income, but could be taxed in the year of actual receipt.

Tribunal's Findings:

The Tribunal examined the orders of the lower authorities and the arguments presented. It noted that the ITO had rejected the assessee's explanation because the loan had not become bad by the end of the financial year and the assessee was maintaining a mercantile system of accounting. The Tribunal found that the AAC had accepted the cash system argument without indicating any factual basis or material evidence. The Tribunal emphasized that the return filed by the assessee indicated a mercantile system of accounting, authenticated by the assessee.

The Tribunal also reviewed the agreement between the assessee and MPD Productions, which stated that the loan and interest were to be repaid by 25-7-1979 or before the release of the film "Chambal Ki Kassam." Despite the assessee's claim that the debtor was in a bad financial position, the Tribunal found no material evidence to support this assertion. The Tribunal noted that the principal amount was eventually recovered, undermining the claim of financial jeopardy.

The Tribunal distinguished the present case from the case of Ferozepur Finance (P.) Ltd., where the financial position of the debtor was undisputedly weak. It also referred to the Supreme Court decision in Morvi Industries Ltd. v. CIT, which held that under a mercantile system, profits or gains accrue even if not realized.

Conclusion:
The Tribunal concluded that the AAC erred in deleting the addition made by the ITO. It held that the interest of Rs. 21,500 should be considered part of the taxable income for the year under consideration, as the assessee had not provided sufficient evidence to support the claim of maintaining a cash system for the loan transaction or the financial jeopardy of the debtor. The Tribunal reversed the AAC's order and restored the ITO's addition.

Result:
The appeal by the revenue was allowed.