1. These are two appeals filed by the assessee-company against the orders under Section 263 of the Income-tax Act, 1961 ('the Act') passed by the Commissioner, Nasik. In these orders, the Commissioner had directed the ITO to include the income from interest amounting to Rs. 1,30,947. In another order, he had directed the ITO that he should also charge interest under Section 217 of the Act, while passing the consequential order in pursuance of the Commissioner's order under Section 263.
2. The assessee is a private limited company. This company is holding controlling shares in two other private limited companies by the name of Lalji Ramji Ginning & Pressing Co. (P.) Ltd. ('Lalji') and Magnotape Co. (P.) Ltd. ('Magnotape'). The assessee-company holds 88 per cent of the shares in Magnotape. The holding-company had been advancing funds to Magnotape. We are concerned with the accounting year ended 30-6-1975. The accounts of Magnotape show advances received from the holding company totalling Rs. 18,55,001 as on the last day of the accounting year. We may say that the accounting year followed by both the companies, is the same.
3. Up to and including the accounting year ended 30-6-1974, the assessee-holding-company was charging interest on such loans. The subsidiary company was also crediting interest to the assessee-company's accounts. This was being taxed in those years.
4. On 30-6-1975, the board of directors of the assessee-company passed a resolution. In that resolution the assessee-company noted, that although the subsidiary-company had come into existence in 1965, it had not yet started production and was in financial difficulties.
Therefore, it would be difficult to recover any interest from such advances which had been lent from time to time. It was, therefore, resolved that interest receivable from the subsidiary companies on those advances would be accounted for on cash basis, but a suitable note would be put in the accounts forming part of the balance sheet for the year ended 30-6-1975. As a consequence of this resolution, the accounts for the year concerned did not show the interest accruing on the advances.
5. The ITO completed the assessment on 12-7-1978 without making any addition on account of the interest due from the subsidiary company.
6. The Commissioner, acting under the powers vested in him under Section 263, held that this order of the ITO was erroneous and prejudicial to the interests of the revenue. He noticed the resolution passed by the directors. He also noticed that the auditors who certified the accounts of the assessee-company had made a note that the interest due on the loans, i.e., interest of Rs. 1,30,947, had not been taken into account. He further noticed as a matter of fact that there is no change in the contract between the assessee-company and the subsidiary company and as per contract the assessee is entitled to charge interest. He was of the opinion that the change-over in the method of accounting is in respect of only one debtor and it is not extended to others. So, it is not possible to say that the entire income falling under the sub-head 'Interest' has been affected by the change in the method of accounting. He pointed out that the subsidiary company had been claiming such interest as a deduction. The assessee-company itself was following the mercantile system of accounting in all other dealings. Nothing has happened, according to the Commissioner, to warrant a change in the method of accounting. He even doubted the bona fides of the resolution and stated that the possibilities of recovering the principal and the interest from the debtor-company were not supported by facts. Even if it is so, it cannot be a ground for making the impugned change. He, therefore, directed the ITO to include the interest amount of Rs. 1,30,947. In another order, he also directed charging of interest as a consequence.
7. Shri Dastur, the learned counsel for the assessee-company, submitted that an assessee is entitled to a change in the method of accounting.
There are two accepted methods of accounting-cash and mercantile. A change from one method to another is a change from one accepted method to another method. He further submitted that the law does not require the assessee to justify a change in the method of accounting. So long as the change was not found to be mala fide, the assessee is entitled to the change. He further submitted that although the assessee cannot be called upon to justify a change, in this case, there is justification for a change. He pointed out that the subsidiary company which had been in existence from 1965, had not been able to start production even after a lapse of 10 years. The subsidiary companies had a lot of hurdles and the assessee-company's funds are locked up therein, without any reasonable prospect of realization of interest or principal. Under these circumstances, it should be a prudent step for the assessee to change the method so that it conforms to realities. He then relied on certain authorities for the proposition submitted by him for consideration.
8. Shri Makhija, for the department, pointed out that there was no justification for change in the method of accounting. He submitted that the circumstances of the subsidiary companies were not so gloomy as to hold that recovery of interest was not possible. The continued losses sustained by the subsidiary companies had not deterred the assessee-company from going on advancing further funds. He pointed out that during the accounting year itself, a further sum of Rs. 7 lakhs had been advanced. The balance as on the first day was about Rs. 11 lakhs and the closing balance was about Rs. 18 lakhs. He further submitted that the assessee had been following mercantile system of accounting and what is being attempted is to single out one transaction and adopt a different method, in respect of that one transaction. He then relied on the decision of the Bombay High Court in the case of CIT v. Confinance Ltd.  89 ITR 292, where the High Court has held that the circumstances mentioned therein were not sufficient to hold that recovery of interest was not possible.
9. We have considered the facts of the case. It is an admitted position that the assessee-company has been accounting for profits on mercantile basis in all these years. It is also an admitted position that even in this accounting year, except for the interests from the subsidiary companies, the rest of the income is being accounted for on mercantile basis. So, the first issue is whether in these circumstances can the assessee change the method of accounting in respect of the income arising from one particular transaction A reference had been made by Shri Dastur to the decision of the Calcutta High Court in the case of CIT v. Eastern Bengal Jute Trading Co. Ltd.  112 ITR 575. That was a case where the entire system of accounting was changed from mercantile to cash basis. The High Court has held that under Section 291 of the Companies Act, the directors had power to change the method of accounting adopted by the company. So long as there were no mala fide motives in changing the method, the assessee cannot be denied the privilege of changing the method of accounting. This decision is not really relevant because we are concerned with the change in respect of only one transaction. But the decision is relevant to this extent that unless mala fide motives could be found, the assessee cannot be denied the privilege of changing its method of accounting.
10. We may at this stage refer to a decision of the Madras High Court in the case of CIT v. Motor Credit Co. (P.) Ltd.  127 ITR 572. In that case, the Madras High Court has held that the regular mode of accounting determines only the mode of computing the taxable income and the point of time at which the tax liability is attracted. It cannot determine or affect the range of taxable income or the ambit of taxation. Where no income has resulted, it cannot be said that income has accrued, merely on the ground that the assessee has been following the mercantile system of accounting. Even if an entry is made in the books, if no income had materialized, there cannot be a liability to tax on a hypothetical income. It is not the hypothetical accrual of income based on mercantile system of accounting that has to be taken into account, but what should be considered is, whether the income has really materialized or resulted to the assessee. On facts in that case, the Madras High Court found that no income had materialized. This case is an authority to hold that unless income materializes a method of accounting followed by the assessee is not relevant. This case did not deal with a change in the method of accounting. In order to apply this ratio, we will have to give a finding that no income accrued, although there was a contract for payment of interest. We can come to such a finding if the balance sheet of the debtor-company revealed a financial position which would show that it had no capacity to repay the principal or interest. We do not find such a position on going through the balance sheet of the subsidiary company. So, we cannot say that what is attempted to be brought into the accounts is only a hypothetical income.
11. In the earlier paragraphs, we have made a reference to the transactions with the subsidiary company alone and we have attempted to find out whether the assessee could change the method of accounting in respect of interest accruing from transactions with the subsidiary company. The resolution passed by the board of directors also makes a special mention only in respect of the subsidiary company's advances.
But as a matter of fact, we found that the change in the method was not in respect of the advances made to the subsidiary company alone. The change is in respect of the income arising under the head 'Interest'.
During the accounting year concerned, the assessee had shown interest of Rs. 1,583. This amount represents interest received during the accounting year. In other words, the method of accounting, entirely on the cash basis (sic). It would appear, therefore, that although the resolution restricted itself to interest from one party, in fact, the accounts show interest income on cash basis only.
12. We, therefore, come to a finding that the change in the method of accounting was in respect of a source of income. Now, it is a settled proposition that an assessee can have different methods of accounting for different sources of income. Section 145(1) of the Act provides that profits and gains of a business shall be computed in accordance with the method of accounting regularly employed by the assessee. In Sarupchand v. CIT  4 ITR 420 (Bom.) and Indo-Commercial Bank Ltd. v. CIT  44 ITR 22 (Mad.), it has been held that it is open to an assessee to make a clean change of the regular method of accounting adopted by him up to that time provided he satisfies the department that he had in fact changed the regular basis of accounting and not merely abandoned or changed it for a casual period to suit his purpose.
These two authorities show that in respect of interest income the assessee can have a separate method of accounting, apart from the method of accounting adopted for other sources of income and it further is an authority to show that in respect of one source of income there could be a change, provided the assessee satisfied the ITO that the change is not casual. On our finding that the change in method is in respect of the income from interest and the change is not casual, we must accept the assessee's contention that he is entitled to such a change.
13. Even in respect of a particular type of income, the Madras High Court has gone further and in the case of CIT v. E.A.E.T. Sundararaj  99 ITR 226, they have held that an assessee may employ one method of accounting for one part of his business or one class of customers and a different method for another part of his business or another class of customers ; that he may also keep accounts in respect of different parts of the same business on different basis. All that will have to be seen is, whether the classification of the business or the customers, as the case may be, is made on a rational basis. It is, of course, necessary to see that by such method no income ultimately escapes tax. If these conditions are satisfied, the department cannot refuse to notice the change in the method of accounting.
14. Shri Makhija relied on the decision of the Bombay High Court in Con-finance Ltd.'s case (supra). This was not a case of change of accounting. In this case, the assessee, who is a money-lender, did not bring into account interest, due from some of his customers. He relied on some of the circumstances of the debtor, to show that no interest has accrued. The Bombay High Court found that the facts of the case did not support the assessee's contention, that no interest has accrued.
This case, in fact, lays down the same proposition of law as the Madras High Court in the case of Motor Credit Co. (supra) to which we have already adverted. The only difference in these two authorities was in respect of facts to which they have to be applied. In respect of the Madras High Court case, the facts were found favourable to the assessee and in respect of the Bombay High Court case, the facts were found to be against the assessee.
15. The reference made by Shri Makhija, to the fact that the assessee-company continued to finance the subsidiary company, is not very relevant to the question before us. It may have some relevance, if our decision has to be based on a finding that the recovery of debt was only a remote possibility. We are not giving such a finding as the earlier paragraphs would show. Our decision is not based on such a finding.
16. We will advert to the reasons given by the Commissioner. He pointed out that nothing whatever has happened during the accounting year to warrant such a change. In our opinion, nothing need happen to warrant a change. It is for the assessee to decide which method he should follow in bringing to the books the income due to him. The Commissioner had further pointed out that the subsidiary company is continuing to claim the deduction on accrual basis. This is not a very relevant fact in determining the question, whether the assessee is entitled to change the method of accounting. This might be relevant if the motives are questioned as mala fide. We are of the opinion that this fact alone is not sufficient to question the motives. The two companies are two different entities. It is possible for the debtor-company to claim that they are entitled to the deduction on mercantile basis, while the creditor-company can claim that the interest could be taxed only on cash basis. Adoption of cash basis by the creditor-company by itself cannot be considered as conclusive for proving mala fides. At worst, it could be considered as a sort of tax planning. It is open for the assessees to plan their transactions in such a way that they attract least amount of tax. We have also our own doubts whether it could be considered as tax planning. It was submitted that the subsidiary company is now doing well. In such a case, it is possible that the accumulated interest will be received and the assessee-company will have to be taxed on cash basis in the coming years.
17. The third objection of the Commissioner is that only one of the several debts had been picked out for a change in the method of accounting. We have dealt with this aspect in the earlier part of the paragraphs. We have found that interest has been accounted only on cash basis during this year.
18. The fourth reasoning given by the Commissioner is that the allegation that the debts are not recoverable, cannot be a ground for such a change. This assumes that the assessee has to justify his change, in the method of accounting. In our opinion, it is not necessary for the assessee to justify his change. All that he has to do, as we have pointed out earlier, is to show that the change was not mala fide and it was not casual.
19. For these reasons, we accept the assessee's appeals. No interference is called for in the ITO's order. As a consequence, there would be no levy of interest under Section 217.