RELEVANT PARAGRAPHS:
8. We have carefully deliberated on the rival contentions raised by the learned AR and DR. The controversy here revolves around charge ability of interest income to the tax which even though technically accrued as per the mercantile-system of accounting being followed by the assessee, but the same was not accounted for as income in view of the peculiar facts and circumstances of the case wherein there was uncertainty regarding ultimate collection of interest. There is no dispute to the well settled legal proposition that income-tax act levies charge of income tax on the total income as per sec. 4 Sec. 5 of the Act defines the scope of total income. The provisions of sec. 145(1) defines that income chargeable under the head “profit and gain of business or profession” or “income from other sources”, shall subject to provisions of sec. 145(2) be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Thus the provisions of sec. 145(1) are subject to the provisions of sec. 145(2), which, in turn, provide that the Accounting Standard, as may be notified by the Central Government from time to time, are to be followed by class of assessee or in respect of any class of income and to that extent, notified accounting standard as AS-I, stipulating that irrespective of whatever be the method of accounting employed by the assessee, it is sine qua non that the financial statements prepared on the basis of such method of accounting must represent a true and fair view of the state of affairs of the business based on the policy of prudence. Therefore, an improvised method of mercantile or cash method of accounting, which may result from such a blending of considerations of prudence with the strict principles of mercantile or cash method of accounting, meets the requirements of sec. 145. From the reading of sec. 145 in conjunction with the charging provisions contained in sec. 4, the scope of total income as defined in sec. 5 and other relevant provisions in the various judgments discussed herein below, the provisions of sec. 145 cannot override sec. 5 of the Act. If income has neither actually accrued nor received within the meaning of sec. 5 of the Act, whatever sec. 145 may say, such income cannot be charged to tax even though a book keeping entry may have been made recognizing such hypothetical income, which in law and in fact did not really accrue or arise or received in the previous year. The provisions of sec. 145 of the Act determines the method of computing the taxable income, it does not effect the range of taxable income or the ambit of taxation. The computation provisions cannot enlarge or restrict the contents of taxable income. Accordingly, the range of taxable income or ambit of taxation is to be determined in accordance with the charging provisions. Even where an assessee is following the mercantile system of accounting, it is only accrual of real income which is chargeable to tax, that accrual is a matter to be decided on commercial belief having regard to the nature of business of the assessee and character of the transaction. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to had to the business character of the transaction and the realities and peculiarities of the situations. Interest income on sticky loans-which has theoretically accrued in favor of the assessee, but has not factually resulted or materialized at all to an assessee during the accounting year, should be regarded as hypothetical income and not the real. There is no reason as to why the factum of sticky nature of loans operating not only through out the accounting period but also in the proceedings years, not on the basis of mere ipse dixit of the assessee, but on being objectively established by showing deteriorating financial position of the concerned debtor and the history of their accounts, should not, have effect on preventing accrual of interest thereon as real income to the assessee. Thus, the stickiness of advances or loans objectively established is sufficient to prevent accrual of real interest thereon as real income and would have the effect of rendering such income hypothetical and the same cannot be brought to tax. Under the Income Tax Act, 1961, in order that income should accrue it should not merely fall due or become legally recoverable, but should also be factual and practically realizable. Factual or practical unrelisibility thereof, may prevent its accrual depending upon the facts and circumstances attending upon the transaction.
9. Under the Income Tax Act 1961, income chargeable to tax is the income received or due to be received in India in the previous year, or income that accrues or arises or is deemed to accrue or arise in India during such year. The computation of such income is to be made in accordance with the method of accounting regularly employed by the assessee. No doubt the Income Tax Act 1961 takes into account two points of time at which the liability to tax is attracted viz., the accrual of income or its receipt; but the
substance of the matter is the income. If the income does not result at all, there cannot be a tax, even though the book keeping entry is made about hypothetical income which does not materialize. The instant case is on more better footing, wherein after realizing & establishing the bad financial position of debtors and no chance of realization of interest income, the assessee had not even passed any entry in the books of account for such interest. The guidance note on accrual basis 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. Following observations of the guidance note are relevant for this purposes:
“3A When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue for the period in which it is properly recognized according to the principles discussed herein.
3.5 Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. Jt is possible that the uncertainty of collection may be either in respect of the entire transaction or a part thereof for that part in respect of which there is no uncertainty of collection, the ‘ revenue is immediately recognized and for the remaining part, recognition of revenue is postponed. In such cases, it may be appropriate to recognize revenue only when it is reasonably certain that the ultimate collection will be made. It is necessary to disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties” .
10. In view of the above, in a situation where there is uncertainty regarding ultimate collection of interest, at the time of raising the claim, the recognition of income on that account should be postponed. In terms of the guidance note, it is appropriate to recognize revenue in such cases only when it becomes reasonably certain that ultimate collection will be made. It is undisputed fact that in the instant case till date both principle and interest remained unpaid, accordingly as per the accepted accounting principle, revenue should be recognized only in the period it is reasonably ascertained that ultimate collection will be made. After the decision of the Hon’ble Supreme Court dated 18.11.1986, in case of State Bank of Tranvancore 158 ITR102, the Hon’ble Supreme Court in its decision in case of UCO Bank 237 ITR 889, vide its order dated 30.5.1999 had considered the concept of the accrual of the income and hold that what could be brought to tax was only the real income accrued to the assessee and that there could be no levy of tax on any hypothetical or illusory income. In this case also, income was not accounted for in respect of interest on sticky advances of a banking company, the Hon’ble Supreme Court held that even though assessee was following mercantile system of accounting, but the interest pertaining to the doubtful loans was not real income in the year in which it accrues but only when it was realized. In the instant case also, it is a matter of record that till date no interest has been received by the assessee nor any amount was received towards refund of principal. Hon’ble Supreme Court in case of Soorji Vallabhdas & Co. 46 ITR 144 and in case of Godhara Electricity Co. Ltd. 225 ITR 746, reiterated that income-tax is not leviable on hypothetical income. Thought the Income Tax Act takes into account two points of time at which the liability to tax is attracted viz., the accrual of income or its receipts, but the substance of the matter is income. If the 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 did not materialize. Therefore, the instant case before us under consideration is on a better footing wherein the assessee has not made any entry in the books of account with regard to such interest which was not realizable at all. After considering the material placed on record, we find that neither any interest nor any principle could be recovered by the assessee till date. The observations made by the CIT(Appeals) to the effect that both the assessee company and borrowing company are known to each other and, therefore, the interest income is bound to accrue and assessee should have accounted for the same as income, is of no substance, in so far as mere knowing each other will not be sufficient to render the financial position of borrowing company better so as to increase the likelihood of interest payment to the assessee company. The observations of the CIT(Appeals) to the effect that assessee was not following the directions of RBI for converting the loans to non-performing assets, is also incorrect, in so far as the balance sheet and other relevant document placed on record clearly indicate that full effect has been given by the assessee with regard to classification of assets as NPA in terms of the prudential norms of RBI. Merely on conjecture and surmises, the CIT(Appeals) has stated that lender and borrowing company have their own scheme to play.
