HIGH COURT OF MADRAS
United Nilagiri Tea Estates Co.
Deputy Commissioner of Income-tax, Company Circle-1(1)
TC APPEAL NO. 278 OF 2006
JULY 17, 2012
Mrs. Chitra Venkataraman, J. – The following is the substantial question of law raised in this Tax Case Appeal filed by the assessee, relating to the assessment year 1998-99:
“Whether the Tribunal was right in law in holding that the interest income has to be taxed on accrual basis under Section 145 of the Income Tax Act, though the same has become irrecoverable?”
2. It is seen from the facts herein that the assessee advanced loan of Rs. 25 lakhs to Credential Finance on 11.5.1995. We may immediately point out herein that the borrower is not a sister concern, though it has been said so in the Tribunal’s order. The assessment order nowhere states this concern as the sister concern. Learned counsel appearing for the assessee/appellant herein also pointed out that the borrower was not a sister concern. It is seen that the company received interest at 24.5% till 16.8.1996. After that, the assessee had not received any interest and it made necessary provision for the year ending 31.3.2001 in respect of the interest receivable by it at 24.5%. Since no amount was forthcoming from the borrower, notice was issued to the borrower to repay the amount. However, in the accounts, the assessee created a contingency reserve for Rs. 25 lakhs. The fact is that the principal amount was not written off.
3. It is stated by the learned counsel appearing for the appellant that by order dated 18.3.2008, the Bombay High Court ordered winding up of the company with effect from 22.4.2002 and the assessee had received Rs. 11 lakhs in the year 2010 in the liquidation proceedings of the borrowing company. However, even in the year 2007, the assessee had written off the said money borrowed by the defaulter company. Looking at the facts herein as were available in the course of the assessment proceedings, the Assessing Authority held that when the amount had not been written off, the assessee had the right to recover the principal amount as well as the interest on accrual basis. Thus, on the mercantile system of accounting followed by the assessee, the Assessing Authority held that the assessee had the accrual of interest at Rs. 6,12,500/-, which was to be recognised as income assessable for the assessment year 1998-99. Aggrieved by this, the assessee went on appeal before the Commissioner of Income Tax (Appeals), who, by order dated 25.2.2002, applied the decision in the case of M/s. Kalaon Tea & Produce Company Limited v. Deputy Commissioner of Income Tax rendered by the Income Tax Appellate Tribunal, ‘C’ Bench, Chennai in its order dated 25th April 2001 and thereby allowed the appeal. The Commissioner of Income Tax (Appeals) held that there could not be an assessment of income on a notional interest and a notional interest could not be treated as real income for the purpose of assessment. The Revenue went on further appeal before the Income Tax Appellate Tribunal. The Tribunal held that the assessee, even though had not received any amount, the principal amount itself was not a bad debt. Hence, interest income on the advance amount had become due. As the assessee was following the mercantile system of accounting, interest accrued therein had to be assessed at the hands of the assessee. Thus, the order of the Commissioner was set aside. Aggrieved by this, the present appeal has been preferred before this Court.
4. Learned counsel appearing for the assessee took serious objection to the line of reasoning of the Tribunal, holding that in the mercantile system of accounting, the accrual of income has to be treated as an income for the purpose of assessment, that even notional income has to be treated as a real income. He pointed out that such line of reasoning of the Tribunal runs contra to the decision of the Apex Court reported in  225 ITR 746 (Godhra Electricity Co. Ltd. v. Commissioner of Income-tax) as well as to the decision of this Court reported in  127 ITR 572 (Commissioner of Income-tax v. Motor Credit Co. P. Ltd.). Given the fact that the assessee had not received any interest beyond May, 1996, rightly, the assessee did not recognise any income even on an accrual basis for assessment for the assessment year 1998-99. He submitted further that considering the improbability of the realisation in the background of the default committed, the Assessing Authority as well as the Tribunal should have allowed the case of the assessee and not to have taxed so, for the accrued interest, as a real income.
5. In the decision reported in  225 ITR 746 (Godhra Electricity Co. Ltd. v. Commissioner of Income-tax), considering the question as to whether, in a mercantile system of accounting, on a mere accrual of an income, there could be any assessment made on a hypothetical income, the Apex Court pointed out that Income Tax Act recognises the accrual of income or its receipt on which the liability to tax is attracted. However, when the subject matter of taxation is income, if the income does not result at all, there could be no tax. Irrespective of the method of accounting, there could be no tax on a hypothetical income.
6. The assessee therein, the Electricity Company, enhanced charges of electricity rate in 1963. Immediately thereon, suits were filed by the consumers, which went upto the Apex Court. The appeals by the consumers were dismissed in the year 1969. Thereafter wards, the Government of Gujarat advised the assessee Electricity Company to maintain status quo on the rates to the consumers for at least six months and the Chief Electrical Inspector was directed to report to the Government about the actual position on the reasonable return earned by the assessee company. In the meantime, there was yet another representative suit by the consumers, which was finally decreed in the year 1974. The Apex Court pointed out to the fact that in spite of enhancement of the charges, the assessee could not realise the enhancement charges in view of the pendency of the suits, followed by the letter of the Government and the subsequent suit and that during the pendency of the subsequent suit, the Undertaking was taken over by the Government of Gujarat. In the background of these facts, the Apex Court pointed out that taking note of the probability or improbability of the rates in a realistic manner, it was not possible to hold that there was real accrual of income to the assessee company in respect of the enhanced charges for supply of electricity. The Supreme Court pointed out that an assessee may opt for cash system or mercantile system of accounting. While in cash system, entries are made on the basis of actual receipts and disbursements, in the mercantile system of accounting, it is on accrual basis that the income is computed. However, the concept of real income would be applicable irrespective of whether the accounts are maintained in cash system or in the mercantile system. If the accounts are maintained in the mercantile system, it is necessary to see whether the income could be said to have really accrued to the assessee company. Referring to a series of decisions, the Apex Court pointed out from the decision of the Bombay High Court reported in  39 ITR 706 (Bom) (H.M. Kashiparekh & Co. Ltd. v Commissioner of Income-Tax), which reads as under:
“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. It will lay greater emphasis on the business aspect of the matter viewed as a whole when that can be done without disregarding statutory language.”
7. Referring to the decision reported in  158 ITR 102 (SC) (State Bank of Travancore v. Commissioner of Income Tax (Appeals)), the Apex Court pointed out:
“…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 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 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’. “
8. In the background of the law thus laid down, what is to be looked at to test the real income that might be taken for working out an assessment for an assessee following the mercantile system of account is, the chances or probabilities of realisation in a realistic manner to hold that there was a real accrual of income to the assessee company. Applying the said decision to the facts herein, the assessee was in receipt of interest till 16th August 1996. Thereafter, the admitted fact is that the assessee did not receive any income. The assessee also did not make any other claim as to the improbability of realisation of the interest income, or for that matter, even the principal being repaid.
9. All that the assessee had done during the year ending 31st March 1999 was to create a contingency reserve for Rs.25 lakhs, which is not the same as the assessee forming a probable and reasonable view on the possibility of receiving any interest, even by accrual, was a remote one. Learned counsel appearing for the assessee fairly submitted that the assessee had written off the amount only in the year 2007. Thus, the doubt of improbability of receipt does not appear to have been entertained at all for the assessee at least till 2007 and it made a conscious decision, for reasons best known, to write off the amount only in the year 2007, which means, the assessee did not doubt that there was no probability of real income accrual by way of interest, or for that matter, recovery of the amount due.
10. It is a matter of relevance herein to note that the assessee received Rs.11 lakhs in the liquidation proceedings consequent on the winding up of the company on 18.03.2008 with effect from 22.04.2002. Therefore, even in respect of the debt written off in 2007, the assessee had received Rs.11 lakhs, which may not be in full quit of the amount due and payable to the assessee herein. Even though these facts could not have been there at all for the Tribunal to consider about the recording of the order passed by the High Court in 2008, we are constrained to take note of these facts only to point out that the decision relied on by the assessee reported in  225 ITR 746 (Godhra Electricity Co. Ltd. v. Commissioner of Income-tax), does not, in any manner, advance the cause of the assessee. On the other hand, applying the decision of the Apex Court, we hold that it is difficult to accept the case of the assessee that there was only accrual of a hypothetical income and hence, could not be a subject matter of assessment.
11. It is no doubt true that the Tribunal as well as the Assessing Officer had recorded the fact that the assessee was following the mercantile system of accounting. Hence, the accrual theory of interest income was to be assessed in the year in which it had accrued and had become due.
12. As already pointed out by the Apex Court, in the mercantile system of accounting, even though the principle of accrual is followed, the real income theory, nevertheless, has its relevance to find out the assessability of an income. Thus, even though the assessee had followed the mercantile system of accounting, the materials placed before the Assessing Authority and before the Tribunal, do not, in any manner, advance the cause of the assessee to substantiate its contention that the accrued interest was only hypothetical income and hence, not available for taxation. Thus, taking note of the test laid down by the Apex Court and taking note of the conduct of the parties herein in writing off the amount in the year 2007, we have no hesitation in holding that the order of the Tribunal does not call for any interference by this Court.
13. As far as the decision of this Court reported in  127 ITR 572 (Commissioner of Income-tax v. Motor Credit Co. P. Ltd.) is concerned, the said decision, in turn, applied the decision of the Apex Court reported in  46 ITR 144 (CIT v. Shoorji Vallabhdas and Co.), which, in turn, was applied in the decision of the Apex Court referred to above. The facts in the reported decision in  127 ITR 572 (Commissioner of Income-tax v. Motor Credit Co. P. Ltd.) show that the routes in which the buses were plied by the firms was taken over by the Cheran Transport Corporation Ltd., and on account of the taking over, the two firms defaulted in making the payment of the hire purchase instalments. Considering the impossibility of recovery of the amount lent to these firms, by initiating legal proceedings, there being not even remote possibility of any interest income materialising, this Court held that no liability to tax could be imposed on the mere ground that interest had accrued because of the mercantile system of accounting employed by the assessee. The reported decision of this Court is distinguishable on facts before this Court. As already pointed out, in the absence of any material to suggest as to the impossibility or improbability of realisation of the amount even for accrual, we have no hesitation in confirming the order of the Tribunal.
14. As already pointed out, even though the Tribunal has rejected the assessee’s appeal and allowed the Revenue’s appeal and thereby restored the assessment on the ground that in the case of mercantile system of accounting, accrual alone has to be considered as a material aspect in the matter of assessment of an income, following the decision of the Apex Court, we reject the Tax Case Appeal. No costs.