1986 (1) TMI 1 - SC - Income Tax

Held that interest on sticky advance debited to customers but credited to suspense account is assessable to tax - Held that appreciation in the value of foreign balances on account of devaluation of rupee is taxable because it is part of business profits of assessee who is engaged in the business of buying and selling foreign exchange

Issues Involved:
1. Whether the addition of interest on 'sticky' advances as income for the assessment years 1965-66, 1966-67, and 1967-68 was justified in law.
2. Whether the exchange difference arising on the devaluation of the Indian rupee on June 6, 1966, was rightly treated as income for the assessment year 1967-68.

Issue-wise Detailed Analysis:

1. Addition of Interest on 'Sticky' Advances:
The primary issue was whether the interest on 'sticky' advances, which were highly improbable to recover, should be considered as taxable income for the relevant assessment years. The assessee, a subsidiary of the State Bank of India, maintained its accounts on a mercantile basis and credited the interest on these advances to an "Interest Suspense Account" instead of the profit and loss account. The taxing authorities, Tribunal, and High Court rejected the assessee's contention that such interest was not real income and, therefore, not taxable, on the grounds that:
- The assessee followed the mercantile system of accounting, and such interest had accrued at the end of each accounting year.
- The assessee had shown the accrual of such interest by making debit entries in the accounts of the concerned parties.

The High Court relied on its earlier decision in Catholic Bank of India v. CIT [1964] KLT 653, which held that interest on sticky advances was taxable despite directives from the Reserve Bank of India not to include such interest in the profit and loss account. The High Court noted that the facts of the instant case were indistinguishable from those in Catholic Bank's case, except for the absence of a Reserve Bank directive.

The Supreme Court, however, examined whether the theory of real income should apply to exclude interest on sticky loans from taxable income. It was argued that:
- Only real income, not hypothetical income, is chargeable to tax.
- The practice of carrying interest on sticky loans to an "Interest Suspense Account" is a recognized practice in commercial accountancy and consistent with the mercantile system of accounting.
- The doctrine of real income should exclude interest on sticky loans from taxable income if the loans had become sticky due to the deteriorating financial position of the debtors and the history of their accounts.

The Supreme Court concluded that the interest on sticky loans did not constitute real income for the relevant assessment years and should not be taxed. The Court emphasized that the accrual of real income depends on the business character of the transactions and the realities of the situation, not merely on the method of accounting.

2. Exchange Difference on Devaluation of the Indian Rupee:
The second issue was whether the exchange difference arising from the devaluation of the Indian rupee on June 6, 1966, should be treated as income for the assessment year 1967-68. The assessee-bank held foreign exchange as its stock-in-trade, and the devaluation resulted in a surplus of Rs. 1,66,128. The assessee credited this surplus to a "Provision for Contingencies" account and contended that it should not be taxed as it was of a casual and non-recurring nature.

The taxing authorities and the Tribunal rejected this contention, holding that the surplus arose from the business activities of the assessee-bank and was, therefore, a revenue receipt liable to tax. The High Court affirmed this view.

The Supreme Court agreed with the High Court, noting that:
- The foreign exchange held by the assessee was its stock-in-trade.
- Any surplus arising from the devaluation of the Indian rupee was a business receipt and, therefore, taxable.
- The assessee had revalued the cost of foreign exchange in terms of rupees as on the date of devaluation and treated the surplus as its income.

The Supreme Court concluded that the exchange difference arising from the devaluation of the Indian rupee was rightly treated as income for the assessment year 1967-68.

Conclusion:
The Supreme Court allowed the appeals regarding the first issue, holding that the interest on sticky loans was not real income and should not be taxed. However, the appeals were dismissed regarding the second issue, affirming that the exchange difference arising from the devaluation of the Indian rupee was taxable income.

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