2025 (2) TMI 864 - AT - Income Tax

Taxation of interest income - change in the method of accounting from mercantile to cash basis - income of the assessee has to be computed on the basis of cash or mercantile system of accounting - HELD THAT - Assessee has changed the method of accounting from mercantile system to cash system in the year under consideration. In this respect justifiable reasons and corroborative actions taken have been explained by the assessee. Assessee is a non- corporate assessee who is permitted to follow either of the cash or mercantile system of accounting for recognizing his income. In the case of companies they are mandatorily required to follow accrual basis of accounting. Change in method of accounting is not prohibited when warranted by situations which has been justifiably explained by the assessee. Assessee had demonstrated that once changed he has regularly followed the method in the subsequent years. Assessee has affirmed to offer the income as and when he receives it. In our considered view change of method of accounting from mercantile to cash by the assessee in the year under consideration is a legitimate exercise. Assessee has explained that it is a genuine and bonafide exercise arising out of compelling reasons of financial distress at the end of borrowers. Subjecting assessee to tax on interest income which he has not received we have held the change in method of accounting from mercantile to cash system justifiable and legitimate. Having held so non-receipt of interest income during the year from both the parties namely in the case of SPCPL where assessee has waived the interest which has not even been accrued by it in its books of account to claim it as an expense and Roxanna having accrued the interest expense in its books of account has not paid the same to the assessee cannot be added in the hands of the assessee on accrual basis as done by the ld. AO No infirmity in the findings arrived at by ld. CIT(A) in deleting the addition made by AO towards interest income on loans given to the two companies. In the result grounds raised by the Revenue are dismissed.

1. ISSUES PRESENTED and CONSIDERED

The core legal issues considered in this judgment are:

Whether the change in the method of accounting from mercantile to cash basis by the assessee is permissible under Section 145 of the Income Tax Act.
Whether the assessee is liable to be taxed on interest income that was neither received nor accrued during the assessment year in question.
Whether the actions of the CIT(A) in deleting the additions made by the Assessing Officer were justified.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Change in Method of Accounting

Relevant Legal Framework and Precedents: Section 145 of the Income Tax Act allows income to be computed in accordance with either the cash or mercantile system of accounting, provided it is regularly employed by the assessee. The term "regularly" does not imply permanence, and a change in the method of accounting is not prohibited if justified by circumstances.
Court's Interpretation and Reasoning: The Tribunal interpreted "regularly" as not meaning "permanent," allowing for a change in the method of accounting when justified. The assessee's change from mercantile to cash basis was deemed legitimate due to financial distress faced by the borrowing companies.
Key Evidence and Findings: The assessee provided evidence of financial distress at SPCPL and Roxanna, justifying the change in accounting method. The Tribunal noted that the change was consistently followed in subsequent years.
Application of Law to Facts: The Tribunal applied Section 145, concluding that the change in accounting method was valid, as it was a bona fide exercise due to compelling financial reasons.
Treatment of Competing Arguments: The Tribunal dismissed the Revenue's argument that the change was an afterthought to defer tax liability, emphasizing the genuine financial difficulties faced by the borrowing companies.
Conclusions: The change in the method of accounting was justified and permissible under the circumstances.

Issue 2: Taxation of Interest Income

Relevant Legal Framework and Precedents: Under Section 145, income should be computed based on the method of accounting regularly employed. The principle of real income, as established in judicial precedents, dictates that only income that has actually materialized can be taxed.
Court's Interpretation and Reasoning: The Tribunal held that since the interest income was neither received nor accrued due to the waiver and financial distress, it could not be taxed in the hands of the assessee.
Key Evidence and Findings: The waiver of interest by the assessee was documented in SPCPL's financial statements, and Roxanna had not paid the interest despite accruing it.
Application of Law to Facts: The Tribunal applied the principle of real income, concluding that the interest income could not be taxed as it did not result in real income for the assessee during the assessment year.
Treatment of Competing Arguments: The Tribunal rejected the Assessing Officer's addition of interest income on an accrual basis, emphasizing the lack of actual receipt or accrual.
Conclusions: The interest income was not taxable in the assessment year due to non-receipt and waiver.

3. SIGNIFICANT HOLDINGS

Core Principles Established: The judgment reinforced the principle that a change in the method of accounting is permissible when justified by circumstances. It also affirmed that only real income, which has materialized, can be taxed.
Final Determinations on Each Issue: The Tribunal upheld the assessee's change in the method of accounting and ruled that the interest income was not taxable in the assessment year since it was neither received nor accrued.
Verbatim Quotes of Crucial Legal Reasoning: "What can be taxed, is only real income. If income does not result at all, there cannot be a tax, even though in book keeping an entry is made about a hypothetical income which does not materialize."
The appeal of the Revenue was dismissed, affirming the CIT(A)'s decision to delete the additions made by the Assessing Officer.