1. The only ground of appeal in the present departmental appeal is that the AAC erred in deleting Rs. 21,500 added by the ITO in respect of the interest on loan advanced by the assesses.
2. The assessee is a firm consisting of two partners having equal shares. The assessee was being assessed in the status of registered firm and the method of accounting was noted in the assessment order to be mercantile. The accounting period ended on 31-3-1980. The ITO noted in the assessment order that the assessee disclosed income from commission and interest on loans and advances to various parties. He found that the assessee advanced Rs. 1,00,000 to MPD Productions, a distributor of films on 25-4-1979 and 20-5-1979 for Rs. 75,000 and Rs. 25,000, respectively. He observed that in terms of the agreement, interest at the rate of 2 per cent was payable by the said concern to the assessee. He found that the assessee had not charged interest although the assessee's system of accounting was mercantile. The assessee explained that the money was advanced to MPD Productions, Bombay, against security of picture, 'Chambal Ki Kassam' in eastern unit at the rate of 2 per cent interest and, since the picture was not released in the eastern circuit due to bad picture, money was not realised and the , assessee did not know whether Rs. 1,00,000 would be realised at all and the interest on the loan was not credited in the account. The ITO declined to accept the statement of the assessee stating that for the simple reason the loan did not become bad by the end of the financial year and the assessee was maintaining mercantile system of accounts and there was no reason not to charge the interest in terms of the agreement. Before the ITO, copy of the pleader's notice dated 10-5-1980 was produced, by which the concerned parties were forbidden not to have any dealings with MPD Productions in respect of the release of the said picture till the loan due to the assessee together with interest were fully paid up. According to the ITO, this pleader's notice had no relevancy at all. In the circumstances, interest calculated at Rs. 21,500 was included in the assessment.
3. The assessee preferred an appeal before the AAC contending that when the recovery of the principal amount of loan itself was in jeopardy, there was no reason to show the unreal income from interest every year.
It was further stated that as the debtor was unable to pay even the principal amount, there was no question of receiving any interest from the said debtor. It was also argued before the AAC that the assessee maintained cash system of accounts in connection with the said loan transaction whereas in respect of the other incomes of the assessee, the mercantile system of accounting has been followed. According to the assessee, the assessee could employ different methods of accounting and the profit would be computed in accordance with the respective methods, while referring to the decisions in the cases of Fatehchand Chhakodilal v. CIT  13 ITR 198 (Nag.), J.K. Bankers v. CIT  94 ITR 107 (All.) and CIT v. E.A.E.T. Sundararaj  99 ITR 226 (Mad.). It was also argued that it was quite evident that in connection with the said loan, the assessee maintained cash basis of accounts and that was why when no amount of interest was received, the assessee did not show it in the accounts. It was also submitted that if the accounts were maintained on cash basis, income would be chargeable only when the same was received, referring to the decisions in the cases of CIT v.Maharajadhiraja Kameshwar Singh of Darbhanga  1 ITR 94 (PC) and Raja Raghunandan Prasad Singh v. CIT  1 ITR 113 (PC), etc.
4. The AAC considered the arguments made on behalf of the assessee. He found strong force in those arguments. The AAC further observed that in various decisions, it had also been decided that the choice of method of accounting lies with the assessee B.C.G.A. (Punjab) Ltd. v. CIT  5 ITR 279, 299 (Lahore). He also noted that the department was bound by the assessee's choice of method of accounting which could not be rejected merely because it gives the assessee some benefits in certain year--CIT/EPT v. Chari & Ram  17 ITR 1 (Mad.), Juggilal Kamlapat, Bankers v. CIT  101 ITR 40 (All.) and CIT v. K.Doddabasappa  54 ITR 221 (Mys.). The AAC observed that in the instant case, there was no doubt regarding the fact that the realisation of the principal amount of the loan had become very much doubtful and the assessee and gone to the extent of taking a legal help for realisation of the principal amount and unless there was some doubt in realisation of the principal amount, it was not expected of anybody that he would go to seek legal help. He also noted that since the assessee was maintaining cash system of accounts in connection with this particular loan transaction (as is evident from the fact that the assessee stopped showing amount of interest as the same was not realisable), the AAC felt that the unrealised interest should not be treated as income of the assessee during the year under consideration.
He was, therefore, of the opinion that the alleged interest of Rs. 21,500 cannot be treated as part of the taxable income of the assessee.
He, however, indicated that the ITO would be free to tax the same in the year of actual receipt. Hence, this appeal before us by the revenue.
5. It is urged by the learned departmental representative that there was no justification for the AAC on the facts of the case to delete the above sum which was the income of the assessee from the computation of the income as made by the ITO. It is vehemently urged on behalf of the revenue that the AAC acted erroneously in coming to the conclusion that the assessee was maintaining cash system of accounting in respect of the loan transaction. It is pointed out before us that the assessee in the return of income for the year at Annexure 'D', in which certain particulars were to be furnished by the assessee, has clearly indicated that the method of accounting for the year was mercantile. Photostat copy of that page of the return is placed in our file. It is urged further that before the ITO the assessee never took the plea that cash system was adopted in respect of the loan transaction, as this would be contrary to the facts of the case. It is strongly urged on behalf of the revenue that the assessee had been following the mercantile system regularly and only for the year under consideration, it was claimed for the first time before the AAC that cash system was followed in respect of that particular transaction and that too without any supporting evidence or materials. It is pointed out that the ITO considered the pleader's notice issued by the assessee to the debtor, which is stated to have been made after the close of the accounting year. It is pointed out that no step had been taken by the assessee to recover the loan as in fact the loan had not become bad or doubtful as claimed before the AAC. It is pointed out that in the accounts of the assessee, the said loan of Rs. 1,00,000 was still shown as recoverable. It is, therefore, urged that it was not understood as to how the assessee claimed that the interest was not recoverable in spite of the agreement made between the parties. It is also urged on behalf of the revenue that the AAC has simply accepted the statement of the assessee without bringing any material fact or evidence on record. It is also pointed out that the principal amount was actually realised subsequently, i.e., after the accounting year. It is, therefore, submitted that all these facts would show that the AAC has allowed the appeal by the assessee erroneously and, therefore, his order requires to be reversed and that of the ITO may be restored.
6. The assessee's learned counsel, however, resists the submissions made on behalf of the revenue contending that the loan was given to the above Bombay party in two instalments with a stipulation that the same would be returned within a period of three months. According to him, the entire loan was due to be repaid by 25-7-1979. It is urged that as per the terms of the agreement, the debtor should have paid the amount before the date or before the release of the above film, whichever is earlier. It is stressed that as the interest was not received, real income was not shown in the return. In respect of the declaration made by the assessee in the return that the method of accounting during the year was mercantile, it is urged that the return form was filled up by the employee, whereas in fact the account in respect of the loan transaction was maintained on cash basis. It is urged that even the interest was not credited in the accounts and the same was not reflected in the balance sheet. In fact, before us, arguments made before the AAC are repeated and stressed on behalf of the assessee. In course of his arguments, the assessee's learned counsel refers to the decision in the case of CIT v. Ferozepur Finance (P.) Ltd.  124 ITR 619 (Punj. & Har.) in order to stress that if the income did not result at all, there cannot be levy of tax and even if an entry of hypothetical income is made in the books of account, where the income does not result at all as there is neither accrual nor receipt of income, no tax can be levied. It is further pointed out by the assessee's learned counsel that in that decision, a similar claim of the assessee was allowed and the departmental special leave application [SLP (Civil) No. 8158 of 1981] before the Hon'ble Supreme Court was rejected as reported in 144 ITR St. 50. It is, therefore, urged that in view of this situation, the claim of the assessee was validly allowed by the AAC. Further, reference is made to the decision of the Hon'ble Supreme Court in the case of CIT v. A Raman & Co.  67 ITR 11, in which, inter alia on the facts of that case, it was held that the law does not oblige a trader to make the maximum profit that he can out of his trading transaction and that income which accrues to a trader is taxable in his hands. It was held that income which he could have, but has not earned, is not made taxable as income accrued to him. The assessee's learned counsel further refers to the decision of the Hon'ble Bombay High Court in the case of H.M. Kashiparekh & Co. Ltd. v.CIT  39 ITR 706, in which, inter alia, it was held that the two rules that income-tax is annual in its structure, meaning thereby that for computation each year is a distinct self-contained unit, and the other that the income to be taxed is the real income of the assessee are not incompatible or irreconcilable and they permit of harmonious application. At the time of hearing, the assessee's learned counsel refers to various pages of the paper book in order to stress the stand taken by the assessee before us. In brief, it is urged that on the facts of the case and in view of the decision in various cases, the claim of the assessee was rightly allowed by the AAC, whose order requires to be confirmed.
7. We have perused the orders of the authorities below along with the other papers placed before us for our consideration. It is seen that the ITO has given a finding in the assessment order that he declined to accept the explanation of the assessee for the simple reason that the loan did not become bad by the end of the financial year and the assessee was maintaining mercantile system of account. However, before the AAC, it was urged that the assessee maintained a cash system of accounting in respect of the loan transaction. The AAC accepted this part of the argument of the assessee. But he has not indicated on what basis, fact or material, the above conclusion was arrived at. As pointed out on behalf of the revenue, in the relevant part of the return filed by the assessee, the method of accounting followed by the assessee for the year under consideration was mercantile. The contention of the assessee before us is that the form was filled up by the advocate, who computed the income. In our opinion, this stand of the assessee cannot be accepted, as in the declaration part of the return, the correctness, completeness, etc., of the return has authenticated by the assessee itself.
8. From the papers placed before us, it is seen that as per agreement made between the assessee and MPD Productions, the entire amount of Rs. 1,00,000 plus interest at the rate of 2 per cent would be repaid back to the assessee on or before 25-7-1979 or before release of the picture 'Chambal Ki Kassam', whichever date is earlier. In the agreement dated 26-5-1979, the debtor also agreed to undertake that he would not release or caused to be released the said picture until the above principal and the interest amount was fully and finally paid to the assessee and the above arrangement is stated to be irrevocable. But the claim of the assessee is that the debtor was in a bad financial position and in fact recovery of the principal amount itself was in jeopardy. This, in our opinion, is only an assertion of the assessee.
Assertion remains an assertion. It has not been shown before us that the financial position of MPD Productions was bad or MPD Productions itself was declared insolvent. That apart, in the undertaking dated 26-5-1979, it was stated that the arrangement was irrevocable. On the other hand, the assessee has placed a letter of the assessee dated 25-11-1982 in which the debtor informed the assessee that Damani Pictures (P.) Ltd., Calcutta (Distributors on behalf of MPD Productions) was instructed to make payment to the assessee in full and final settlement of the above loan taken including the payment of the principal amount and interest, etc. It was further stated that MPD Productions shall not be liable to make any further payment on account of interest, etc. According to the assessee, the amount of Rs. 1,00,000 was received from the above distributors on 27-11-1982. But in spite of the terms of the undertaking noted earlier and in terms of the agreement made between the parties, it is seen that no further step was taken by the assessee in this regard.
9. In the books of the assessee Rs. 1,00,000 was shown to be due as balance from MPD Productions even up to the assessment year 1983-84, during which receipt of Rs. 1,00,000 on 1-12-1982 was noted. From the copies of the correspondences placed before us, it is seen that the loan was recoverable during the year and in fact the same was subsequently recovered as discussed by us above. In our opinion, the ITO was justified in coming to the conclusion that the assessee had not shown the said loan to be bad or doubtful during the accounting year itself, as in fact the loan was recoverable. In our opinion, the facts relating to the year under consideration should only be taken into account as far as the income-tax matters are concerned. That apart, in the instant case, there is no indication that the debtor was in a bad financial position. In the case of Ferozepur Finance (P.) Ltd. (supra), relied on behalf of the assessee, the facts are completely different.
Briefly speaking, the facts of that case were that the ITO called for explanation of the assessee for not charging any interest on the amount due from one party. It was claimed that the financial position of that party was bad and there was no hope of recovery even of the principal amount and, therefore, it was not considered necessary to charge any interest. The ITO added interest at the rate of 12 per cent in the total income of the assessee. On appeal by the assessee, the AAC sustained the action of the ITO. When the matter was taken up before the Tribunal (Chandigarh Bench), the claim of the assessee was allowed and the addition made by the ITO was deleted on the basis that the department did not seriously dispute the fact that the financial position of that debtor was weak. The Tribunal took note of the financial position of that debtor for those years and it noticed that there was a sale of all the properties of the debtor in order to satisfy certain obligation, which would show that the financial position of the debtor was not sound. Ultimately, on the facts of that case, the Hon'ble High Court sustained the decision of the Tribunal in allowing the claim of that assessee. The facts before us are different.
Apart from the assertion that the recovery of the principal amount was in jeopardy, no material fact or evidence has been placed before the lower authorities or before us. There is absolutely no basis for us to say that the financial position of MPD Production was bad and, therefore, it would not be necessary also by the assessee to show the interest as income during the year.
10. In the case of H.M. Kashiparekh & Co. Ltd. (supra), relied on by the assessee, the facts were different. Itwas noted in that Bombay High Court case that under the managing agency agreement, that assessee was under a duty to forego up to one-third of its commission, etc., payable and, therefore, the amount foregone by the assessee could not be included in the real income of the assessee for the accounting year.
The facts before us are distinguishable, inasmuch as there is no material to say that the assessee has foregone or waived the interest due from the assessee as in fact the principal amount, though claimed to be in jeopardy, was realised subsequently. In our opinion, the assessee's claim on the facts of the case was wrongly allowed by the AAC.11. In this connection, we may refer to the decision of the Hon'ble Supreme Court of India in the case of Morvi Industries Ltd. v. CIT  82 ITR 835, which was not considered by the Hon'ble Punjab and Haryana High Court in the case of Ferozepur Finance (P.) Ltd. (supra).
Briefly speaking, the facts of that case were that the assessee, which was the managing agent of the subsidiary company, maintained accounts on mercantile system and it was entitled to receive an office allowance, a commission at the rate of 12 1/2 per cent of the net profit of the managed company in addition to additional commission.
During the accounting year concerned, the managed company suffered losses and the assessee earned only commission on the sale of cloth.
Under the managing agency agreement the commission was due to the assessee by the end of the accounting year and it was payable immediately after the annual accounts of the managed company had been passed in the general meeting, which was held subsequently, during which the assessee relinquished its commission on sales and office allowance because the managed company had been suffering heavy losses in the past years. The Tribunal held that the relin-quishment by the assessee after it had become due was of no effect. As a result of the relinquishment, the financial position of the managed company did not become stronger while that of the assessee-company became weeker and, therefore, the relinquishment was not for the benefit of the assessee.
On reference, the High Court agreed with the view of the Tribunal. The Hon'ble Supreme Court affirmed the decision of the Hon'ble High Court.
Inter alia, it was also held that where the accounts are kept on mercantile basis, the profits or gains are accrued though they are not actually realised and the entries those made really show nothing more than an accrual or arising of the said profits at the material time.
12. Having regard to the facts of the case, as found by the authorities below and as discussed by us above, and having regard to the submissions made before us and in view of what we have discussed in the preceding paragraph, we are of the clear view that the AAC erred in deleting the addition made by the ITO in respect of the above sum of Rs. 21,500. In this view of the matter, the action of the AAC cannot be sustained. His order is, therefore, reversed and that of the ITO is restored.