1978 (9) TMI 83 - AT - Income Tax

Issues Involved:
1. Inclusion of unrealized interest credited to the interest suspense account in taxable income.
2. Validity of the change in the method of accounting by the assessee.
3. Applicability of the Reserve Bank of India's circular and CBDT's letter.
4. Relevance of precedents from various High Courts.

Detailed Analysis:

1. Inclusion of Unrealized Interest in Taxable Income:
The CIT directed the ITO to include unrealized interest credited to the interest suspense account in the taxable income for the assessment years 1974-75 and 1975-76. The CIT deemed the ITO's omission to include these amounts as erroneous and prejudicial to the interests of Revenue. The CIT relied on the Kerala High Court decision in State Bank of Travancore vs. CIT, which held that interest accruing on sticky advances should be included as income assessable under the mercantile system of accounting.

2. Validity of the Change in the Method of Accounting:
The assessee, a financial corporation constituted by the Kerala State Government, argued that under Section 145 of the IT Act, income assessable under the head profits and gains of business should be computed in accordance with the method of accounting regularly employed by it. The assessee contended that it is permissible to change the method of accounting, provided it is bona fide and not intended to avoid tax. The change was made following a circular from the Reserve Bank of India, which suggested that unrealized interest should not be shown as income to present a true picture of the actual income of the corporations.

3. Applicability of the Reserve Bank of India's Circular and CBDT's Letter:
The Reserve Bank of India's circular dated 21st November 1973, advised State Financial Corporations to credit unrealized interest to the interest suspense account instead of the profit and loss account. The Central Board of Direct Taxes (CBDT) had also issued a letter stating that amounts kept in suspense accounts under the heads interest, commission, etc., would not be assessable to tax. The assessee adopted this method even for the accounting year ending 31st March 1973. The CIT, however, did not accept the applicability of the CBDT's letter to the assessee, stating it was specific to the Haryana State Government's financial corporation.

4. Relevance of Precedents from Various High Courts:
The assessee's representative cited decisions from the Calcutta High Court, which supported the view that a bona fide change in the method of accounting should be accepted if it does not result in income escaping assessment. The Departmental Representative, however, relied on decisions from the Kerala High Court, including Catholic Bank of India Ltd. vs. CIT and other cases involving the State Bank of Travancore, which supported the inclusion of accrued interest as income under the mercantile system of accounting. The Tribunal noted that the Kerala High Court decisions did not consider the specific argument of a bona fide change in the method of accounting.

Tribunal's Conclusion:
The Tribunal concluded that the change in the method of accounting by the assessee was bona fide and not intended to avoid tax. The change was made following the Reserve Bank of India's circular to present a true picture of the corporation's income. The Tribunal held that the amounts credited to the interest suspense account should not be included in the taxable income for the assessment years 1974-75 and 1975-76. Consequently, the orders of the CIT were set aside, and the orders of the Income Tax Officer were restored.

Final Judgment:
The appeals were allowed, and the orders of the CIT for both the assessment years were set aside. The Tribunal restored the orders of the Income Tax Officer.

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