9911796707
TMI Blog1986 (1) TMI 1X X X X Extracts X X X X X X X X Extracts X X X X ..... of the State Bank of India; it maintains accounts on mercantile system making entries on accrual basis; it adopts the calendar year as its previous year and the calendar years 1964, 1965 and 1966 are, respectively, the relevant previous years for the assessment years 1965-66, 1966-67 and 1967-68 to which the question relates. In the course of its banking business, the assessee charged interest on advances considered doubtful of recovery, otherwise called sticky advances, by debiting the concerned parties but instead of carrying it to its profit and loss account credited the same to a separate account styled " Interest Suspense Account " as the principal amounts of these sticky advances themselves had become, not bad or irrecoverable but extremely doubtful of recovery. However, in its returns, the assessee disclosed such interest separately and claimed that the same was not taxable in its hands as income for the concerned years. The amounts so charged to the concerned parties but credited to the " Interest Suspense Account " were Rs. 67,170, Rs. 47,777 and Rs. 57,889 for the assessment years 1965-66, 1966-67 and 1967-68, respectively. Before the taxing authorities, as also before t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... question whether there was accrual of income or not and that in the case before it also, there was accrual of income to the assessee considering the mercantile method of accounting that had been regularly adopted by it. In this view of the matter, the High Court answered the question against the assessee and in favour of the Revenue. Incidentally, it may be stated that in the case of this very assessee, the High Court, following the decision herein, took a similar view and answered a similar question against the assessee for the subsequent year 1968-69 which decision rendered in 1975 is reported as State Bank of Travancore v. CIT [1977] 110 ITR 336. The assessee has challenged this view before us in these appeals. Mr. Palkhivala, the learned counsel for the assessee, raised a two-fold contention in support of his plea that the three sums representing interest on " sticky " advances, i.e., advances in respect whereof there was high improbability of recovery of even the principal amounts, ought not to have been subjected to tax as income under the Act. In the first place, he contended that what are chargeable to income-tax in respect of a business are profits and gains actually resu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 36(1)(vii) of the Act while the latter is a loan to which a high degree of improbability of recovery attaches in a particular year or years depending upon the financial position of the concerned debtor due to which interest thereon becomes hypothetical income during such year or years and, as such, the same, not being real income, cannot be brought to tax. Counsel pointed out that right from August 1924 onwards till the impugned decision herein as also the further decision in State Bank of Travancore v. CIT [1977] 110 ITR 336, were rendered by the Kerala High Court in 1973 and 1975, respectively, the aforesaid distinction between an irrecoverable loan and a sticky loan was recognised by the Central Board of Revenue as also by the Reserve Bank of India in their diverse circulars in the case of banks, financial institutions and money-lenders regularly following the mercantile system of accounting and he further pointed out that instructions had been issued not to treat the unrealised interest on such sticky loans as income by carrying it to the profit and loss account so that the figure of distributable profits should not get inflated and preferably to credit the same to a sp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and business interests and policies of several financial institutions including foreign banks, six interveners, namely, American Express International Banking Corpn., Mercantile Bank Ltd. through its successors Hongkong & Shanghai Banking Corpn., Citi Bank N.A., Chartered Bank, Grindlays Bank and Industrial Credit & Investment Corpn. of India, sought our permission to intervene in these appeals and we granted the requisite permission in view of the importance of the issues involved and it may be stated that counsel appearing for the interveners have adopted the arguments of Mr. Palkhivala and generally supported the submissions made by him on behalf of the assessee in these appeals; but special mention may be made of the fact that in the written submissions filed on their behalf, it has been categorically asserted that while maintaining their accounts regularly on mercantile system, each one of these institutions in the matter of interest on doubtful or sticky loans invariably follow the practice of debiting such interest to the account of the concerned borrower but, instead of crediting it to interest account or profit and loss account, the same is carried to a special account st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncerned assessment years. Counsel for the Revenue fairly conceded that courts have, while imposing the tax liability under the Act, recognised the theory of real income by having regard to the business character of the transactions and realities of the situation but these aspects have been taken into account for the purpose of determining whether the income could be said to have legally accrued or not and once it is found to have legally accrued, it is brought to tax. He pointed out that all the decisions of this court show that this theory has been invoked and confined only to two types of cases: (a) where there has been a surrender of income which may in theory have accrued, and (b) where there has been diversion of income at source either under statute or by overriding title, but in none of these cases has the aspect of high improbability of recovery been regarded as sufficient to prevent accrual ; counsel, therefore, urged that this theory of real income should not be extended so as to exclude from chargeability such income which has accrued but merely suffers from high improbability of recovery. Counsel submitted, such extension would be neither permissible nor advisable-not p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the light of decided cases. The material provisions in regard to the computation of income of an assessee under the head " Profits and gains of business " are to be found in sections 28(i), 29 and 145(1) but these have to be read subject to section 5 of the Act. Section 28(i) taxes the profits and gains of any business carried on by the assessee at any time during the previous year and such profits and gains are, under section 39, to be computed in accordance with the provisions contained in sections 30 to 43A, that is to say, after making allowances and deductions mentioned in those sections. Section 145(1) provides that income chargeable under the head " Profits and gains of business " shall be computed in accordance with the method of accounting regularly employed by the assessee, provided that, in any case where the accounts are correct and complete to the satisfaction of the Income-tax Officer but the method is such that, in his opinion, the income cannot be properly deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax Officer may determine; but where he is not satisfied about the correctness or completeness of the accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofits system of accountancy " or the " complete double entry book-keeping " has been described by Sri Iqbal Ahmad C.J. in CIT v. Singari Bai [1945] 13 ITR 224 at 227 (All), as follows: " Under this system, the net profit or loss is calculated after taking into account all the income and all the expenditure relating to the period, whether such income has been actually received or not and, whether such expenditure has been actually paid or not. That is to say, the profit computed under this system is the profit actually earned, though not necessarily realised in cash, or the loss computed under this system is the loss actually sustained, though not necessarily paid in cash. The distinguishing feature of this method of accountancy is that it brings into credit what is due immediately it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed." The distinction between these two accounting systems has been adverted to by this court in several of its decisions but I need refer only to one decision in CIT v. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), where the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... against the book profits some of the bad debts may have to be set off when they are found to be, irrecoverable. Besides the cash system and the mercantile system, there are innumerable other systems of accounting which may be called hybrid or heterogeneous in which certain elements and incidents of the cash and mercantile systems are combined. " On the aspect as to how far and to what extent a method of accounting has a bearing on the question of real accrual of income, the court has made the following significant observation at page 128 of the report: " But the section (section 13 of the 1922 Act equivalent to section 145 of the 1961 Act) only deals with the computation of income, profits and gains for the purposes of sections 10 and 12 (sections 28 and 56 of the 1961 Act) and does not purport to enlarge or restrict the content of taxable income, profits and gains under the Act. " Obviously, for the content of taxable income, one must have regard to the substantive charging provisions of the Act. This decision, in my view, has emphasised two important aspects in regard to the two methods of accounting usually employed by businessmen. In the first place, the court has pointed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lier, the claim was negatived by the taxing authorities and the Tribunal on the ground that the advances or loans had not been treated as irrecoverable or bad debts under section 36(1)(vii), that the aspect that the advances or loans had become sticky was irrelevant, that since the assessee was following the mercantile system of accounting, such interest had accrued to it at the end of each accounting year and that the assessee had itself shown the accrual Of interest by charging the same to the concerned parties by making debit entries in their accounts. The High Court also affirmed the view that there had been accrual of the income at the end of each accounting year and in that behalf laid emphasis on the fact that the assessee had been regularly adopting the mercantile system of accounting and observed that the assessee's income will have to be determined in accordance with that method. In other words, it is clear that in coming to the conclusion that the three sums in question were liable to be brought to tax, the taxing authorities, the Tribunal and the High Court, relying on the mercantile system employed by the assessee, adopted a legalistic approach and took the view th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns which had become sticky in its books maintained on mercantile system but it had charged such interest by debiting the accounts of the concerned debtors and bad designedly credited it to " Interest Suspense Account " instead of carrying it to the profit and loss account with a view to avoid showing unreal or inflated profits. A " suspense account " in book-keeping means " an account in which items are temporarily carried pending their final disposition ; it does not appear in financial statements. " (vide Kohler's Dictionary for Accountants, Third Edition). Since the final disposition of the sums in question was uncertain and hung in balance, these items were properly carried to " Interest Suspense Account " and could not and did not find a place in the financial statement like the profit and loss account. From the mere fact that such interest was charged to the concerned debtors by making debit entries in their respective accounts, no inference could be drawn that the assessee had regarded it as accrued income because simultaneously such interest was credited to " Interest Suspense Account " and not to profit and loss account. The taxing authorities, the Tribunal and the Hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 's Practical Auditing by W. W. Bigg (Fourth Indian Edition by S.V. Chatalia), the learned author has suggested that instead of leaving irrecoverable interest on doubtful loans out of account altogether the practice of charging such interest to the parties concerned but crediting it to the Interest Suspense Account is more appropriate for reflecting the correct state of affairs and the true profits. The relevant passage occurring at pages 186-187 runs thus: " Where interest has not been paid, it is sometimes left out of account altogether. This prevents the possibility of irrecoverable interest being credited to revenue, and distributed as profit. On the other hand, this treatment does not record the actual state of the loan account, and in the case of banks and other concerns whose business it is to advance money, it is usual to find the interest is regularly charged up, but when its recovery is doubtful, the amount thereof is either fully provided against or taken to the credit of an Interest Suspense Account and carried forward, and not treated as profit until actually received." Reference may also be made to the Approved Text of the International Accounting Standard 18 (Su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n it becomes legally recoverable irrespective of whether it is actually received or not and " accrued income " is that income which " the assessee has a legal right to receive ". Incidentally, it may be stated that in both of these cases, where the legal aspect of accrual has been explained, no question of applying the doctrine of real income could arise; for, in the former case, after the commission payable to the managing agents had accrued at the end of the accounting year, the managed company had, instead of paying it, kept it in a suspense account pending settlement of a dispute in regard to another debt owed to it by the managing agents (which proposed settlement was ultimately rejected) and the court held that such keeping it in the suspense account pending settlement of another indebtedness would not prevent its accrual to the managing agents, while in the other case a unilateral relinquishment of the commission by the managing agents was after its accrual and hence the court ruled that it could not escape liability to tax. While the legal aspect of accrual thus holds good, this court in CIT v. Shoorji Vallabhdas & Co. [1962] 46 ITR 144, has enunciated the doctrine of real ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of income which had already accrued, but an agreement to receive a lesser remuneration than what had been agreed upon. The court relied upon the fact that the assessee had in fact received only the lesser amount in spite of the entries in the accounts books and held that such lesser amount alone was taxable. A large number of decisions rendered by this court as well as by the High Courts were cited at the bar by counsel on either side in which this aforesaid theory of real income has been invoked and applied and in some of them emphasis has been laid on the aspect that accrual is matter of substance to be decided on commercial principles having regard to the business character of the transactions and the realities of the situation. After having gone through these decisions, I am in agreement with the submission of the learned counsel for the Revenue that these decisions involving the application of the concept fall into two groups : (a) cases where there has been a surrender or relinquishment of income that may have theoretically accrued, and (b) cases where these has been diversion of income at source either under a statute or by overriding title; but in both types of cases, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... go) in December, 1950. Though the Appellate Tribunal found that the excess amount of Rs. 57,785 had also been given up for reasons of commercial expediency, it held that the maximum amount which could be forgone by the assessee was only Rs. 39,215 and, therefore, included the excess amount of Rs. 57,785 in the taxable income. On reference, the High Court held that it was the real income of the assessee company for the accounting year that was liable to tax, that the real income could not be arrived at without taking into account the amount forgone by the assessee and that in ascertaining the real income, the fact that the assessee followed the mercantile system of accounting did not have any bearing. The court further held that the accrual of commission, the making of the accounts, the legal obligation to give up part of the commission and the forgoing of the commission at the time of the making of the accounts were not disjointed facts; there was a dovetailing about them which could not be ignored and, therefore, the real income of the assessee was Rs. 27,644 and the amount of Rs. 97,000 forgone by the assessee could not be included in the real income of the assessee for the accou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the two rules to particular transactions, regard must be had to the true legal rights and the true situation. A fair interpretation of the transaction and the situation would lead to a preferable and, if we may say so, a correct solution than sheer adherence to one rule and discounting of the other." At page 720 of the report, the court went on to observe thus: " In the course of his argument, learned counsel for the Revenue stated that there must have been entries in the books of the managed company and the managing company in consonance with clause 5 of the managing agency agreement ... We shall proceed on the footing that the assessee-company having followed the mercantile system of account, there must have been entries made in its books in the accounting year in respect of the amount of the commission. In our judgment, we would not be justified in attaching any particular importance in this case to the fact that the company followed the mercantile system of account. That would not have any particular bearing in applying the principle of real income to the facts of this case. Incidentally, we may observe that we ourselves pointed out in the case of Commissioner of Income-ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ully approved by this court in Birla Gwalior P. Ltd.'s case [1973] 89 ITR 266 (SC). It will thus be clear that even under the mercantile system of accounting whenever adopted, it is only the accrual of real income which is chargeable to tax, that accrual is a matter of substance and that it is to be decided on commercial principles having regard to the business character of the transactions and the realities and specialities of the situation and cannot be determined by adopting purely theoretical or doctrinaire or legalistic approach. If, therefore, for the purpose of determining whether there has been accrual of real income or not, regard is to be had to the business character of the transactions and the realities and specialities of the situation in preference to theoretical, doctrinaire or legalistic approach, I fail to appreciate why interest on sticky loans, which has theoretically accrued but has not factually resulted or materialised at all to an assessee during the accounting year, should not be regarded as hypothetical income and not real income. There is no reason why the factum of stickiness of loans operating throughout the accounting period or periods, not on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he extension of the theory of real income as sought would entrench upon section 36(1)(vi). Secondly, it was urged that such extension will be ill-advised inasmuch as, if done, it will apply to cases of interest accruing to all money-lenders and not merely to cases of interest accruing to banks and financial institutions. As regards the first objection, the argument amounts to saying that the exclusion or deduction in respect of irrecoverable and bad debts under section 36(1)(vii) read with the conditions mentioned in sub-section (2) proceeds on the basis that in substance such debts do not constitute real income of the assessee and, therefore, exclusion of interest on sticky loans from the computation of income for which there is no provision in the Act and that too without any conditions would impinge upon the specific provision contained in section 36(1)(vii) read with sub-section (2). The answer to this objection is that it is not as if that in the absence of some specific provision, exclusion of hypothetical income cannot be done ; in fact, such exclusion rests not upon any slippery or slushy ground but upon the principle that under the Act, chargeability is attracted only to r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of the taxing authority that the loans in question had in fact become sticky during the concerned year or years by producing proper material and that they have invariably followed the practice of carrying the interest on such loans to Interest Suspense Account instead of crediting the same to interest account or profit and loss account with the additional safeguard of offering the same for taxation if and when it is subsequently realised. It will be pertinent to mention in this connection that the earlier circulars issued by the Central Board of Revenue and the Reserve Bank of India (vide C. B. R. Circular No. 37/54, dated August 25, 1924, No. 41(V-6) D of 1952, dated October 6, 1952, CBDT's Letter F. No. 207/10/73 ITA II, dated April 16, 1973, and RBI Circular IFD No. O.P.R. 1076/1(5) to SFCs dated November 21, 1973) which conferred the benefit of excluding such interest on sticky loans albeit by way of concession were applicable to private money-lenders also. In the circumstances, both the objections are liable to be rejected. I may now deal with the decisions of the High Courts. Directly on the point at issue there are five decisions which we need consider. Out of these, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... #39;s case [1960] 39 ITR 706 (Bom), to the facts of the case but the High Court declined to do so by adopting a legalistic approach that the assessee had been following the mercantile system of accounting, that the interest had accrued and further laid considerable emphasis on two aspects, namely, that none of the debts due by the several debtors was written off by the assessee and no evidence was produced to show that interest in respect of the debts was given up. In my view, the High Court failed to appreciate that the method of accounting employed by an assessee merely determined the mode of computing the income and not the range of taxable income and further failed to notice that there could be and was clear distinction between an irrecoverable or a bad debt on the one hand and a sticky loan on the other to which we have adverted earlier. In James Finlay's case [1982] 137 ITR 698 (Cal), decided by the Calcutta High Court, the items of interest receivable from two parties on advances made to them were sought to be excluded from the computation of income of the assessee for 1970-71 on the ground that since January 1, 1968, the assessee had decided to change its method of acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d interest on the amounts outstanding from these two firms. The Appellate Assistant Commissioner deleted the addition. The Tribunal held that the assessee could not have expected to get any interest income on the outstandings found due from the two firms and it would be wholly unrealistic on the part of the assessee to take credit for the interest income and consequently confirmed the Appellate Assistant Commissioner's order. On reference at the instance of the Commissioner, the Madras High Court held that the Tribunal was right in its conclusion that though the assessee had adopted the mercantile system of accounting, no interest income could be assessed in its hands on accrual basis and it would be very unrealistic on the part of the assessee to take credit for the highly illusory interest. Following the decision of this court in Shoorji Vallabhdas Co.'s case [1962] 46 ITR 144 (SC) and of the Bombay High Court in Kashiparekh's case [1960] 39 ITR 706 (Bom), the High Court took the view that the regular mode of accounting merely determined the mode of computing the taxable income and the point of time at which the tax liability was attracted and it could not determine o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n currency held by it would be its stock-in-trade and if foreign currencies bought at the pre-devaluation rate of exchange were sold at post-devaluation rate of exchange resulting in a surplus, the same would be its business receipt or revenue receipt and, therefore, liable to tax as part of business profits. Indisputably, just before the devaluation of the Indian rupee on June 6, 1966, the assessee-bank held foreign exchange by way of cash balances available with their foreign correspondents, forward contracts, items in transit, etc., amounting to $ 33,780.76 in US dollars and pounds 9552.0.2 in sterling which when converted back to rupees at the post-devaluation rates gave rise to a profit of 57.5% or Rs. 1,66,128 in the transaction ; the assessee-bank credited this surplus to an account designated " Provision for contingencies ". It was contended on behalf of the assessee before the lower taxing authorities that this profit should not be taxed as it was of a casual and non-recurring nature. The contention was negatived by the authorities on the ground that even assuming, without conceding, that it was a windfall and, therefore, of a casual nature, the same had arisen from the bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on or book appreciation in the value of the stock and, as such, the same could not be brought to tax. There can be no dispute with regard to the principle that if stock-in-trade remains unused or unsold, the mere book appreciation in the value thereof cannot be brought to tax but on the facts requisite to sustain the proposition, the assessee-bank does not seem to stand on any firm footing. In the first place, by carrying the surplus resulting from the devaluation of the Indian rupee to an account designated " Provision for contingencies ", the assessee bank itself could be said to have clearly treated such surplus as its business income. Secondly, the Appellate Assistant Commissioner in his appellate order has recorded a categorical finding that the stock-in-trade in terms of foreign currency was sold and used by the assessee in its normal banking business. This is what the Appellate Assistant Commissioner has observed : " What is important is that the profit on account of the difference in exchange rate should have arisen in the course of trading operations of the bank. There is no doubt that it did so arise in the instant case. The bank acquired and sold the foreign exchange as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness used to charge interest on advances, including even those which it considered doubtful of recovery and which the assessee termed as " sticky advances " by debiting the concerned parties but instead of carrying the same to its profit and loss account, credited the same to a separate account called " Interest Suspense Account ". According to the assessee, the principal amounts of these advances labelled as " sticky advances " had become not bad or irrecoverable, but extremely doubtful of recovery. In its returns, the assessee had disclosed such interest separately and claimed that the sums were not taxable as income of the concerned years. In view of the relevant years involved, the question must be considered in the light of the provisions of the Income-tax Act, 1961 (hereinafter called " the Act:). Before the taxing officers, the Tribunal and the High Court, the assessee's contention was that having regard to the bad and deteriorating financial condition of the parties concerned as well as the history of their accounts, the recovery of even the principal debts had become improbable and doubtful, thereby making these loans or advances, as the assessee called " sticky " a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tantive part of the section makes it clear that the income is to be computed 'in accordance with the method of accounting regularly employed'. The Income-tax Officer may include in the computation of income an amount which does not figure in the accounts but the inclusion of which is required by the assessee's method of accounting; that is to say, the Income-tax Officer, may, without deviating from the assessee's method, make such adjustments in the profit and loss account as are necessary for giving full and true effect to that method itself. Having adopted a regular method of accounting, the assessee cannot be allowed to change it or depart from it for a particular year or for part of the year or in respect of particular transactions. " The High Court of Kerala was of the view that the facts of the instant case out of which these appeals arise being the same as those in Catholic Bank's case [1964] KLT 653 (Ker), except that there was a direction from the Reserve Bank of India to Catholic Bank, which is absent in the instant case before us, the same conclusion must follow. In the opinion of the High, Court, the presence or absence of such direction from the Re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stem of accounting, accrual of " real income " in the commercial sense only was chargeable to tax and this must accrue in substance according to the realities of the situation. It was submitted that if regard is had to the realities of the situation as well as actual commercial principles, it would be evident that in cases of banks, financial institutions and moneylenders, bulk of the income is usually earned by way of interest and as such there cannot be any accrual of real income from interest on doubtful advances or sticky advances and, therefore, the entries made in respect of such accounts in the cases of all such traders following the mercantile system of accounting only reflected hypothetical income which does not materialise as income. It was submitted that, therefore, it was proper to carry such interest to " Interest Suspense Account " as carrying the same to the profit and loss account would amount to showing an unreal and inflated profit and thereby lead to improper and illegal distribution or remittances thereof. Therefore, the question is, whether on the theory of real income, interest which had accrued legally to an assessee-in this case a banking institution-follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r taxation of recoveries in subsequent assessment years. There is also a letter dated April 16, 1973, from the Under Secretary, Central Board of Direct Taxes, referring to D.O. letter dated March 15, 1973, reiterating that the amounts kept in suspense account under those circumstances would not be taxable. The assessee was, however, required to maintain a systematic method of accounting in respect of doubtful debts subject to checks and counter-checks. By the letter dated November 21, 1973, the Reserve Bank of India wrote that there was no uniformity in the practice followed by the State Financial Corporations on sticky loans where the same position was reiterated. A letter was written on June 20, 1978, by the Central Board of Direct Taxes to the Commissioners of Income-tax soon after the decision rendered in the assessee's case in State Bank of Travancore, [1977] 110 ITR 336, referred to hereinbefore, In that letter, reference was made to the previous circulars and it was pointed out that the stand taken in these circulars was not acceptable to the Revenue Audit Department and it had objected to the exclusion of such amounts of interest from the total income. The Board advised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. The profits and gains chargeable to tax under the Act are those which have been either received by the assessee or have accrued to the assessee during the period between the first and the last day of the year of account and are receivable. Income received or income accrued are both chargeable to tax under section 28 of the Act. The computation of this income is provided for in section 29 of the Act. While we are on the sections, it may be appropriate to refer to section 36 also. Section 36(1) provides for certain deductions from the computation of income and clause (vii) thereof deals with bad debts in these terms: " (vii) subject to the provisions of sub-section (2), the amount of any debt, or part thereof, which is established to have become a bad debt in the previous year; " Section 36(2) prescribes the conditions to be satisfied for earning deduction for a bad debt. There is no dispute in these appeals that such conditions are not satisfied. Section 56 of the Act deals with income from other sources and section 57 deals with deductions in the computation of income from other sources. Section 145 deals with the method of accounting. Sub-section (1) of the said section pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ement of the dispute, resolved to keep the sum of Rs. 2,26,850 in suspense without paying it. The sum of Rs. 2,26,850 was debited as a revenue expenditure of the company and was allowed as deduction in computing the profits of the company for purpose of income-tax. The question was whether in the assessment year 1942-43, the assessee was liable to pay tax on the sum of Rs. 2,26,850. The Tribunal held that the assessee was being assessed on cash basis in previous years, that the income had not accrued to the assessee and that the sum of Rs. 2,26,850 should be excluded from taxation as not having been received in the accounting year. The High Court came to the conclusion that there was no material for the Tribunal's finding that the assessee was being assessed on cash basis in the previous years but held (Satyanarayana Rao J. confirming the decision of the Appellate Tribunal Viswanatha Sastri J. contra) that the sum of Rs. 2,26,850 was notable to tax, inasmuch as it was not income of the assessee which had accrued or arisen in the accounting year. This court in appeal held that the High Court was right in its conclusion that there was no material for the Tribunal's finding th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the assessee for his own purposes-in this case for the purposes of the company's business-and does not relate to a method of making up the statutory return for assessment to income-tax. Secondly, the section clearly makes such a method of accounting a compulsory basis of computation unless, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced therefrom. It may well be that, though the profit brought out in the accounts is not the true figure for income-tax purposes, the true figure can be accurately deduced therefrom. The simplest case would be where it appears on the face of the accounts that a stated deduction has been made for the purpose of a reserve. But there may well be more complicated cases in which nevertheless, it is possible to deduce the true profits from the accounts, and the judgment of the Income-tax Officer under the proviso must be properly exercised. It is misleading to describe the duty of the Income-tax Officer as a discretionary power." Iqbal Ahmad C.J. has aptly described in CIT v. Singari Bai [1945] 13 ITR 224 (All), the mercantile system of accountancy and has observed at page 227 of the report as follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ipts during the year and the actual cash outlays during the year are treated in the same way as tinder the cash system, but to the balance thus arising, there is added the amount of the outstandings not collected, it the end of the year and from this is deducted the liabilities incurred or accrued but not discharged at the end of the year. Both the methods are somewhat rough. In some cases, these methods may not give a clear picture of the true profits earned and certainly not of taxable profits. The quantum of allowances permitted to be deducted under diverse heads under section 10(2) from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining in sub-section (5), the word 'paid ' which is used in several clauses of sub-section (2) as meaning actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under section 10. Again where the cash system is adopted, there is no question of bad debts or outstandings at all, in the case of mercantile system against the book profits some of the bad debts may have to be set off when they are found to be irreco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e managing agency transferred to two private companies and the subsequent agreement in the following year, viz., December, 1948, was merely fructification or carrying into effect of that desire and as a result of the same, the income did not accrue. That this was the basis for the ratio of the decision of this court would be clear because this court referred to and relied on the decision of the Bombay High Court in CIT v. Chamanlal Mangaldas & Co.[1956] 29 ITR 987 (Bom) in this respect. That was also a case of managing agency company's entitlement to receive commission at a certain rate. By another agreement, in that case, the commission earned by the managing agent for the calendar year 1950 was reduced to Rs. 1 lakh. That agreement, i.e., the subsequent agreement, took place during the previous year and the resolution of the board of directors of the managed company was also in the previous year but it was, however, made final on April 8, 1951, at a meeting of the board of directors but at a time beyond the previous year. The High Court bad taken the view that by reason of the resolution during the currency of the previous year, the right of the assessee to commission ceased ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... system of accounting differed substantially from the cash system of book-keeping. Under the cash system, it was only actual cash receipts and actual cash payments that were recorded as credits and debits ; whereas, under the mercantile system, credit entries were made in respect of the amounts due immediately they became legally payable and before they were actually received. Similarly, the expenditure items for which legal liability had been incurred were immediately debited even before the amounts in question were actually disbursed. This position was reiterated by this court in 1971, after taking into consideration various decisions of this court. In our view, therefore, the concept of real income cannot be so used as to make accrued income non-income simply because after the event of accrual, the assessee neither decides to treat it as bad debt nor claims deductions under section 36(2) of the Act, but still enters the same with a diminished hope of recovery in the suspense account. Extension of the concept of real income to this field to negate accrual after the amount had become payable is contrary to the postulates of the Act. It may be mentioned that before the decision of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were not sufficient to pay a dividend of 6 per cent. For the accounting year ending on December 31, 1950, the assessee had earned a commission of Rs. 1,17,644 but as a result of resolutions passed by the managed company and the assessee company, the assessee gave up a sum of Rs. 97,000 in December, 1950. The Appellate Tribunal held that the maximum amount the assessee was bound to forgo was only Rs. 39,215 and included the balance of the amount forgone, viz., Rs. 57,785, in the taxable income. The Tribunal, however, found that the sum of Rs. 57,785 was also given up for reasons of commercial expediency. The Division Bench of the Bombay High Court held that it was the real income of the assessee company for the accounting year that was liable to tax and that the real income could not be arrived at without taking into account the amount forgone by the assessee. In ascertaining the real income, the fact that the assessee followed the mercantile system of accounting did not have any bearing. The accrual of the commission, the making of the accounts, the legal obligation to give tip part of the commission and the forgoing of the commission at the time of the making of the accounts were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... peculiar situation arising out of the managing agency agreement that subsequently a sum of Rs. 97,000 was given up in December, 1950, for the assessment year ending on March 31, 1950. In this context, the fact of surrender and the concept of real income must be viewed. It was really to implement the obligation under the managing agency agreement that the giving up took place. Therefore, the accrual of commission, the making of the accounts, the legal obligation to give up part of the commission and the forgoing of the commission at the time of the making of the accounts were considered not to be disjointed facts. There was dovetailing about these which in the reality of the situation could not be ignored. This is not a case where there being no previous obligation after interest having been earned in the sense of having accrued according to the mercantile system of accounting, the assessee after the close of the accounting year without giving up the interest which the assessee could have as a bad debt, did not offer it for taxation but carried it to " Interest Suspense Account ". Carrying certain amount which had accrued as interest without treating it as bad debt or irrecoverable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt for the payment of the commission, the mere fact that the respondent was maintaining its accounts on the mercantile system did not lead to the conclusion that the commission had accrued to it by the end of the relevant accounting year. The commission given up by the respondent could not be considered to be its real income. It is clear that the fact of the case was that the managing agency commission receivable by the assessee could have been ascertained only after the managed company had made up its accounts and as it had not made up its accounts, the commission did not accrue to the assessee company and, therefore, the giving up which was for valid reasons was not given up after the accrual of income. Dealing with Kashiparekh's case [1960] 39 ITR 706 (Bom), this court observed that an argument was advanced before this court that as the assessee was maintaining its accounts on mercantile basis, the commission had accrued. This contention did not find favour with this court, because this court noted that no due date was fixed for payment of the commission under the managing agency agreement. Therefore, whether in a particular case, managing agency commission had accrued or n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as well as Birla Gwalior P. Ltd.'s case [1973] 89 ITR 266 (SC), have been discussed and analysed. In that case, the accounts of the assessee company for the year 1970-71, included an amount of Rs. 8,264 from B & G and Rs. 55,920 from S. P. Ltd. receivable as interest. The interest due from B & G were on advances made in 1966 and that from S. P. Ltd. were on advances made in 1965. The assessee was following the mercantile system of accounting and the Income-tax Officer treated both the items of interest as the assessee's income for 1970-71. The assessee used to credit the interest to its profit and loss account. It urged that it had decided to change with effect from January 1, 1968, its method of accounting in respect of interest which was doubtful of recovery and that such interest was thenceforward credited to the suspense account. The Tribunal held that there was no change in the method of accounting and that before the closing of the books of account of the relevant accounting year, the assessee had not abandoned its claim for interest and, as such, the amounts were assessable on accrual basis. On a reference, the High Court held that the alteration of practice in book ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... private company, was carrying on business as financier for purchase of motor vehicles on hire purchase. It advanced under hire-purchase agreements monies to two firms which were plying buses. The routes of these two firms having been taken over by a State Transport Corporation following nationalisation, the firms defaulted in making payment of the hire-purchase instalments, and, consequently, the buses were seized. As the assessee-company was advised that there was no prospect of recovering even the principal amount, the assessee-company did not credit the interest on the outstandings from the two companies, even though it was adopting the mercantile system of accounting. The Income-tax Officer, however, included a sum of Rs. 56,163 by way of accrued interest on the amounts outstanding against these two firms. There, in fact, no interest accrued in view of the facts that there was hire-purchase and the State Transport Corporation had taken over the firms. Therefore, there was no question of paying any hiring charges or interest. In that view, it was considered to be unrealistic that income accrued. If the actuality of situation or the reality of a particular situation makes an inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... date of default to the date of delivery of the prints and also provided certain sum for certain contingency. It is not necessary to set out in detail the further facts. It was held that the assessee was in a position to realise only Rs. 3,47,000 approximately during the three years in question as against a total sum of Rs. 4,37,828 incurred as the cost of production. The Tribunal was justified, in the High Court's view, that having regard to the terms of the agreement entered into between the parties and in the light of the entries contained in the accounts, the commission could not be said to have accrued in favour of the assessee, as commission could be earned only after the entire advance had been realised. The decision, as is apparent from its tenor, rested upon the peculiar facts. As the advances could not be realised because of the contingencies that happened in that case, the commission did not accrue or could not be said to have actually accrued. As mentioned before, the concept of real income may have to be given precedence in the computation of income in a particular case but accrued income cannot be waived as not having accrued to the assessee. Sethuraman J., who del ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or whether real income has materialised or not, various factors will have to be taken into account. It would be difficult and improper to extend the concept of real income to all cases depending upon the ipse dixit of the assessee which would then become a value judgment only. What has really accrued to the assessee has to be found out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in realistic manner and dovetailing of these factors together but once the accrual takes place, on the conduct of the parties subsequent to the year of closing an income which has accrued cannot be made " no income ". The extension of such a value judgment to such a field is pregnant with the possibility of misuse and should be treated with caution; otherwise one would be on sticky grounds. One should proceed cautiously and not fall a prey to the shifting sands of time. As a result of the aforesaid discussion, the following propositions emerge: (1) It is the income which has really accrued or arisen to the assessee that is taxable. Whether the income has really accrued or arisen to the assessee must be judged in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ughout. RANGANATH MISRA J.-I have had the advantage of reading the two separate judgments by my learned brethren, Tulzapurkar and Mukharji JJ. I am in agreement with both of them that the second question had been correctly answered in favour of the Revenue by the High Court and the appeals are to be dismissed on affirmation of that conclusion so far as that aspect is concerned. In regard to the answer proposed for the first question, I have bestowed my careful consideration and I am in agreement with the reasonings and conclusions reached by my learned brother, Mukharji J. I am of the view that section 36(2) of the Income-tax Act covers the entire field regarding deduction for bad debt. Though the concept of " real income " is a well-recognised one, it cannot be introduced as an outlet of income from the taxman's net for assessment on the plea that though shown in the account books as having accrued, the same became a bad debt and was not earned at all. It is well settled that the citizen is entitled to the benefit of every ambiguity in a taxing statute but where the law is clear, considerations of hardship, injustice or anomaly do not afford justification for exempting inco ..... X X X X Extracts X X X X X X X X Extracts X X X X
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