Explore the Real Income Theory in Income Tax Law, a court-made concept emphasizing taxation of actual income, not hypothetical earnings. Learn its evolution, judicial acceptance, and exceptions in specific sections of income tax law.
In the legal jurisprudence one of most important conception is the sources of laws and it must be kept in mind that being a most living subject among social sciences, legal jurisprudence not only changes with time adressing the social and econimcal exigencies of a nation but also has to synthesise such changes taking considerations external.
Law is the important product of philosophy apart from science and economics. and customs, legislations and judge made laws are the content of legal jurisprudence. Smilarly real income theory is one of the most important court made theory in income tax law. This theory although is not found in the income tax law but has been evolved by apex court first and then being further enriched by various High corts time to time and principal ethos of this theory is that under income tax law only the real or actual income not the hypothetical income is taxable in the hands of assesseeby interprating the section 2(24) on definition of income under the income tax law and the reason for evolving this vital theory by the apex court was necessiated to dispel the departmental stand that in mercanticle system of accounting both the income accrued in the hands of assessee or on receipt is always taxable irrespective of the fact that no real income has been received by the assessee. By this applying this rule department had tried to implement the acounting division of cash system and mercantile system and went by academic strict interpretation. But Honble apex court hold that to tax the notional income was never the intention of the legislature and first propounded the real income theory in commissioner of Income tax Bombay city-I v. Messrs. Shoorji Vallabhdas and co.(supra) it has been laid down :-
“Income tax is a levy on income no doubt the Income Tax act takes into account two points of time all which the liability to tax is attracted viz the accrual of the income or its receipt; but the substance of the matter is the 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 materialise.
Then the same theory was applied by the apex court and various High courts time to time as under:in H.M. Kashiparekh & co. ltd. v. commissioner of Income Tax (1960) 39 ITR 706 the Bombay High court had said :-
“Even so, (the failure to produce account losses 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 commission in our judgment we would not be justified in attaching any particular importance in this case to the fact that the company followed mercantile system of accounting. They would not have any particular bearing in applying the principle of real income in the facts of this case”.
The said view was approved by this court in commissioner of Income Tax v. Birla Gwalior (p) Ltd. (supra) where the assessee maintained its accounts on the mercantile system. In that case this court after referring to the decision in Morvi Industries Ltd. V. commissioner of Income Tax, (1971)82 ITR 835 which was also a case where the accounts were maintained on mercantile system has said :-
“Hence it is clear that this court in Morvi Industries case did emphasise the fact that the real question for decision was whether the income had really accrued of not it is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income “[p.
273] In Poona Electric supply co. Ltd. V. commissioner of Income Tax Bombay city-I (supra ) this court has said :-
“Income tax is a tax on the real income i.e. the profits arrived at on commercial principles subject to the provisions of the income tax act.”
In that case the court has approved the following principle laid down by the Bombay High court in H.M. Kashiparekh & co. Ltd. v. commissioner of Income tax (supra):-
“The principle of real income is not to be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate in respect or managing agency commission is made agreed to or given on grounds of commercial expediency simply because it takes place some time after the close of an accounting year In examining any transaction and situation of this nature the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it will lay greater emphasis on the business aspect of the matter viewed as whole when that can be done without disregarding statutory language.”
In state bank of Travancore v. commissioner of income tax Kerala (supra ) after considering the various decisions of this court sabyasachi Mukharji J. (as the learned chief justice then was ) has said :-
“An acceptable formula of co- relating the notion of real income in conjunction with the method of accounting for the purpose of taxation is difficult to evolve besides any strait jacket formula is bound to create problems in its application to every situation it must depend upon the facts and circumstances of each case when and how does an income accrue and what are the consequences that follow from actual of income as well settled the accrual must be real taking in go account the actuality of the situation whether an accrual has taken place or not must in appropriate cases be judged on the principles of real income theory After accrual non charging of tax on the same because of certain conduct based on the ipse dixit of a particular assessee cannot be accepted in determining the question whether it is hypothetical income 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 find out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a 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 .”
This important and pivotal theory is now well accepted principal of income tax law and is being strictly followed by all courts and tribunals. However one thing contrary to this principle must be kept in mind and that is there have been in several sections in the income tax law where this theory has no application and that proposition is fully approved by our judiciary. This the deeming provisions like section 68 to 69C and 50C, 56 etc where notional income is taxed inspite of no actual receipt by the assessee and it is judicially settled position that parliament is competent to enact the deeming provision by creating the legal fiction which empowers the department to impose tax on notional income. So real income theory has no application in some specific sections but overall it has accorded great relief particular to the business assesses who usually maintain books in mercantile system.
Author Bio
