Recognition of income on accrual basis to be considered from view point of a prudent assessee

CA Saurabh Chokhra

Brief of the case:

1. The Hon’ble Bombay High Court in the above cited case held that even in mercantile system of accounting an item would be regarded as accrued income only if there is certainty of receiving it and not when it has been waived. Earning of the income, whether actual or notional, has to be seen from the viewpoint of a prudent assessee.

2. Therefore, when the assessee is seeing the recovery of principal probably low then it cannot be forced to recognize the interest income in the name of mercantile system of accounting. In fact, it is not open to anyone to force adoption of accounting policies which result in a distorted view of the affairs of the business.

3. Therefore,earning of the income, whether actual or notional, has to be seen from the viewpoint of a prudent assessee

 Facts of the case:

1. The assessee in year 2003 subscribed to 2% nonconvertible unsecured debentures of Rs.42 crores issued by one of its group companies viz. M/s. Marketing & Brand Solutions (I) Pvt. Ltd. On 31st May, 2004 at a meeting of debenture holder’s waiver of interest on the debentures till 31st March, 2010 was approved. The Board of Directors of the assessee company too on 8^thJune, 2004 also passed a resolution to waive interest on the debentures of M/s. Marketing & Brand Solutions (I) Pvt. Ltd. upto 31st March, 2010 and also duly informed the same to M/s. Marketing & Brand Solutions (I) Pvt.Ltd.

2. In the two assessment years under consideration, the Assessing Officer made addition of Rs.84 lakhs each being 2% interest on Rs.42crores of debentures by Assessment Orders passed under Section 143(3)of the Act. AO added back the waived interest disbelieving the board resolution passed by the assessee company.

3. CIT(A) upheld the order of AO , whereas the ITAT allowed assessee’s appeal holding that because of uncertainty involved in the ultimate collection assessee rightly not recognized the interest income thereby did not offer the same to tax.

4. Aggrieved revenue is in appeal before Bombay HC.

Held by Hon’ble Bombay High Court:

1. High court concurred the view taken by tribunal that even in mercantile system of accounting an item would be regarded as accrued income only if there is certainty of receiving it and not when it has been waived. Earning of the income, whether actual or notional, has to be seen from the viewpoint of a prudent assessee.

2. The guidance note on accrual of income on accounting issued by the ICAI lays down that where the ultimate collection with reasonable certainty is lacking, the revenue recognition is to be postponed to the extent of uncertainty involved.

3. Further, even Sec 145(1) of the Act prescribe that Accounting policies adopted by an assessee should be such so as to represent a true and fair view of the state of affairs of the business, profession or vocation in the financial statements prepared and presented on the basis of such accounting policies.

4. It is not open to anyone to force adoption of accounting policies which result in a distorted view of the affairs of the business.

5. In the instant case, the group company was facing financial troubles which indicate recovery of principal also difficult the fact which the debenture holders acknowledged and accordingly passed a resolution to waive off the interest for a long period of 6 years.

6. Therefore, even under the mercantile method of accounting, and, on peculiar facts of instant case, the assessee was justified in following the policy of not recognizing these interest revenues till the point of time when the uncertainty to realize the revenues vanished.

Accordingly, the appeal of revenue was dismissed.

(Author can be reached at (e)-saurabhchokhra92@gmail.com Mobile-+91 8108393226.)