This is a case stated under Section 66(1) of the Income-tax Act, 1922, by the Income-tax Appellate Tribunal, Allahabad Bench. The material facts of the case are these. The relevant year of assessment is 1957-58, the previous year being the year ending on Diwali in 2013 (October, 1956). The assessee is a registered partnership firm consisting of two persons, Sri Shiv Prasad and Sri Ram Sahai, having equal shares in the profits and losses. The assessee-firm carried on, inter alia, money-lending business and in the course of its money-lending business it had advanced a sum of Rs. 71,010 some time in 1948-49, to another registered firm of M/s. Gwalior Glass Industries (hereinafter called the debtor firm). There were four partner of the debtor firm, two of whom were also partners of the assessee firm. The two other partners were Sri Ram Prasad and Sri Jagdish Prasad. The assessee admittedly adopted the mercantile system of accounting. For the assessment year 1948-49 to 1956-57, the assessee had returned the interest income from the aforesaid loan to the debtor firm on the mercantile system of accounting, i.e., on the accrual basis. In the relevant year of accounting, however, the sum of Rs. 20,400, which had accrued on the said loan was not debited in their accounts. The Income-tax Officer asked the assessee to show cause why the accrued income of Rs. 20,400 should not be included in the assessment. The explanation given was that the debtor firm was in an embarrassed financial condition and, therefore, the interest had not been debited to this account. The Income-tax Officer, on a scrutiny of the details of the account of this debtor in the books of the assessee-firm, found that the assessee had advanced a further sum of Rs. 1,000 on January 6, 1956, and Rs. 18,000 on November 1, 1956, which it would not have done if the debtor firm was in financial straits, and accordingly added a sum of Rs. 30,100 to the income of the assessee as interest accrued at the rate of 12 percent. On Rs. 1,70,000.
On appeal, the Appellate Assistant Commissioner held in favour of the assessee observing :
'No doubt in the immediately proceeding two years, the assessee had debited their account with the interest fallen due from them; but as mentioned above, the assessee did not consider it appropriate to load this particular debtor with an additional amount of interest when there was little hope of even the recovery of the capital.....'
The Appellate Assistant Commissioner accordingly deleted the interest of Rs. 20,400 from the total income of the assessee. The department carried the matter in appeal to the Tribunal which reversed the decision of the Appellate Assistant Commissioner and restored that of the Income-tax Officer. In doing so, the following findings of facts were given :
1. That the assessee had been following the mercantile system of accounting and interest from the debtor firm was being assessed in the past on the accrual basis.
2. There was no variation, change or innovation of the contract in respect of the income of the relevant year of account.
3. That the material placed on record was insufficient to establish that the debtor firm was not able to pay the interest for the relevant year of account, and
4. That both the partners of the assessee-firm, who were also partners of the debtor firm, had not been shown to be financially embarrassed in any manner.
On these findings the Tribunal came to the conclusion that the interest had accrued to the assessee and accordingly held that the interest on Rs. 20,400 should have been taxed in the hands of the assbservations of this court in the case of CIT v. K. Srinivasan and K. Gopalan 23 ITR 87. The High Court was of the opinion that in view of these observations, upon the finding of the Tribunal that the succession took place on October 12, 1948, the Tribunal was right in holding that the assessee was not entitled to the benefit of section 25(4) in the year 1949-50, but he could avail of that benefit in the year 1950-51. The first two questions were, accordingly, answered in the affirmative and in favour of the Revenue.
The moot question is when did the succession, if at all, take place. There was no controversy in that there was succession. The Tribunal had recorded that the succession took place on October 12, 1948. If this is a question of fact as held by the Tribunal and the High Court and as contended by the Revenue, them relief can only be given in the assessment year 1950-51. But is it a pure question of fact or is it a mixed question of law and fact having regard to the relevant scheme of the Act
Section 25 of the Act deals with the assessment in the case of a discontinued business. Sub-section (1) of that section provided that where any business, profession or vocation to which sub-section (3) was not applicable, was discontinued in any year, an assessment might be made in that year on the basis of the income, profits or gains of the period between the end of the previous year and the date of such discontinuance in addition to the assessment, if any, made on the basis of the income, profits and gains of the previous year. Sub-section (2) of section 25 stipulates that any person discontinuing any such business, profession or vocation should give to the Income-tax Officer notice of such discontinuance within fifteen days thereof, and, where any person failed to give the notice required by this sub-section, the Income-tax Officer might direct that a sum shall be recovered from him by way of penalty not exceeding the amount of tax subsequently assessed on him in respect of any income, profits or gains of the business, profession or vocation up to the date of its discontinuance. Sub-section (3) stipulates that where any business, profession or vocation on which tax at any time charged under the provisions of the Indian Income-tax Act, 1918, was discontinued, then unless there was a succession by virtue of which the provisions of sub-section (4) have become applicable, no tax shall be payable in respect of the income, profits or gains of the period between the end of the previous year and the date of such discontinuance and the assessee might further claim that the income, profits and gains of the previous year should be deemed to have been the income, profits and gains of the said period. Where any such claim was made, an assessment should be made on the basis of the income, profits or gains of the said period, and if an amount of tax had already been paid in respect of the income, profits and gains of the previous year exceeding the amount payablhe profits or gains on that basis have been'.
It was further held that it was open to the assessee in certain circumstances to claim that the system should be changed from the mercantile system to that of the cash basis.
The Supreme Court in Commissioner of Income-tax v. K.R.M.T.T. Thiagaraja Chetty & Co., which was a case of a remission of commission, where the method of accounting was on the mercantile basis, held that merely because the agent of a limited company was entitled to a commission and it had accrued and at its request the company had not credited such commission to the account of the a assessee but had carried out to the suspense account by a resolution of the directors, would not make the commissioner which had accrued any the less the income of the assessee, as the system of accounting followed was mercantile system and the commission had accrued. In Commissioner of Income-tax v. Shoorji Vallabhadas & Co. the Supreme Court was again called upon to consider whether the rate of commission which had been agreed upon could be given up by the managing agent and as such what was be the income which could be said to have accrued to the managing agents and as such what would be the income which could be said to have accrued to the managing agents Affirming the decision of the Bombay High Court, it was held that, as the agreement between the managing agents and the managed company with the previous year were replaced and whereby the rate of commission was altered, 'in such as way as to make the income different from that had been entered in the books of account, a mere book entry cannot be income, unless the income has actually resulted and, in the present case, by the change of the earns the income which accrued and which was received consisted t of the lesser amounts and not the larger.... The reduction was a part of the agreement entered into by the assessee-firm.....'
In the absence of any direct authority, but on the first principles it is clear that, once the assessee has adopted the mercantile system of accounting, there is no alternative for the Income-tax Officer but to compute the assessees income on that system, i.e., on the accrual and not the receipt basis. The choice is entirely that of the assessee. He may even chosen to adopt the mercantile system for certain transactions in the cash basis for other transactions, but once having chosen and regularly employed that system, it is not open to him unilaterally at any time during than accounting year to say that he will not now follow that system in respect of a particular transaction. It would be open to the assessee to vary the terms of a particular contract but the variation must be by mutual agreement. It is not open to them to keep alive the contract and his right thereunder, but, of the purposes of income-tax, to say that he will not debit the interest which may have accrued as a debt in its accounts for any reason whatsoever. This is the very evil on accounts of which s section 13 in the Act of 1922 was brought on the statute book. If the assessee could at any moment of time way that he will not debit the interest because of some reason or the other, then it would open the floodgates of evasion. There is also no hardship as the legislature has expressly provide that, if the income on the accrual basis has been included in the assessees total income and tax paid throne bus subsequently it is found that that income was not received or could not be received, then in the year when such debt was found to have become irrecoverable or bad, it we could be claimed as a bad debt. This provision in to be found in section 10(2)(xi) of the Act. This provision also indicate that the legislature never intended an assessee to be able to resale from the mercantile system of accounting and the accrual basis at his sweet will and pleasure. In this view of the matter, it is wholly unnecessary to consider whether the financial position of the debtor was good or not, and whether there was any justification for the assessee not to have made the debit of Rs. 20,400 in the account of this particular debtor. That will be a matter which falls to bad considered if and when the assessee claims the account amounts a bad debt. It will not be right or proper to make any observations on that aspect of the case in these proceedings, as it may embarrass the assessee.
For the reasons given above, the answer to the question will be the affirmative and against the assessee. The assessee will pay the costs of this reference to the department, which we assessee at Rs. 200. Councels fee is also assessed at Rs. 200.