1. The departmental appeal relates to the assessee's assessments for the assessment years 1977-78 and 1978-79 for which the respective previous years are from 1-7-1975 to 30-6-1976 and from 1-7-1976 to 30-6-1977. Cross appeal is by the assessee for the assessment year 1978-79. For the sake of convenience, all the three appeals are disposed of by a consolidated order.
2. The assessee is a registered firm. It has entered into distributorship agreement dated 24-12-1974 with Kamani Metallic & Oxide (P.) Ltd. ('Kamanis'). The agreement is for a period of three years with a provision for renewal on mutual agreement. Clause 13 provides for termination of the agreement by giving four months' notice in writing by either party and clause 12 of the agreement provides for a deposit of Rs. 10 lakhs by the assessee or by its nominees with Kamanis, which is to carry an interest at the rate of 12 per cent per annum. The assessee had given a notice of termination of distributorship agreement to Kamanis on 18-7-1975 in terms of which the termination of the agreement became effective on and from 18-11-1975.
By means of a letter, dated 29-10-1975, the assessee has requested Kamanis to refund the amounts deposited in three equal instalments in terms of clause 12.
3. The assessee has not charged interest on the amount remaining as deposit with Kamanis for both the previous years under reference, on the ground that the principal amount was itself in jeopardy and that, therefore, no income by way of interest accrued to the assessee during the previous years. However, the ITO has rejected the assessee's claim observing that the assessee is following mercantile system of accountancy and, therefore, interest did accrue to it on the outstanding amounts from year to year.
4. It is pertinent to mention that the assessee's appeal for the assessment year 1978-79 came up for hearing before the Commissioner (Appeals), who heard it on 16-3-1984 and disposed it by her order dated 12-4-1984. For elaborate reasons given in paras 3, 3(a) and 3(b) of her order particularly following the Supreme Court decision in the case of CIT v. Shoorji Vallabhadas & Co.  46 ITR 144, the Punjab and Haryana High Court decision in CIT v. Ferozepur Finance (P.) Ltd.  124 ITR 619 and the Calcutta High Court decision in CIT v.Naskarpara Jute Mills Co. Ltd.  141 ITR 384 she has accepted the assessee's claim that on the facts and in the circumstances of the case, no income by way of interest can be said to have accrued to the assessee during the previous years. In view of the decisions relied upon, she also held that the fact that the assessee was following the mercantile system of accountancy would not change the position when the income has not accrued at all. For the assessment year 1977-78, the appeal came to be heard by the AAC, who has heard it on 9-12-1982 and disposed it by his order dated 16-12-1982. Since the order of the Commissioner (Appeals) for the assessment year 1978-79 was available to him, the AAC has also following the order of the Commissioner (Appeals) deleted the addition by way of assumed interest income for the assessment year 1977-78.
5. It is submitted before us by Shri Mahadeshwar, the senior departmental representative, that the Commissioner (Appeals) for the assessment year 1978-79 and the AAC for the assessment year 1977-78 have failed to appreciate the facts correctly. In this context, he has invited our attention to the fact that when Kamanis did not refund the amounts to the assessee, the assessee filed a suit being No. 282 of 1976 in the Bombay High Court on 18-2-1976 and that by their order passed by the Hon'ble High Court on 23-4-1981, the Hon'ble High Court passed a decree in favour of the assessee both for the refund of the principal amount as well as the interest thereon. The counter claim by Kamanis for recovery of Rs. 3,98,852, was stated to be dismissed.
Accordingly, the senior departmental representative vehemently contended that the appellate authorities were not justified in accepting the assesee's claim that income by way of interest had not accrued to the assessee for the relevant previous years.
According to him, in the absence of a dispute that the assessee is following the mercantile system of accountancy, interest accrued has got to be taxed.
6. Shri Kapadia, the learned Counsel for the assessee, on the other hand, strongly relied on the order of the Commissioner (Appeals) for the assessment year 1978-79, which has been followed by the AAC for the assessment year 1977-78. In particular, he stated that it was not quite correct to say that the assessee was following the mercantile system of accountancy. As per clause 12 of distributorship, the interest was payable every half yearly on the 30th June and 31st December every year. The assessee was receiving credit notes from Kamanis on the receipts of which it was crediting the profit and loss account and debiting the Kamanis account. The last credit note, it is stated was received on 5-7-1975 for the half year ending on 30-6-1975.
Accordingly, the amount mentioned in the credit note was credited to the profit and loss account. The assessee having given the notice of termination of agreement soon thereafter, i.e., on 18-7-1975, in terms of which the termination of the agreement became effective from 18-11-1975, the question of receiving any credit note thereafter, did not arise. In this manner, it is submitted by the counsel that technically speaking, the assessee was not actually following the mercantile system in respect of this transaction. It is submitted that when instead of refunding the amounts deposited, the Kamanis filed a counter claim for Rs. 3,98,852, it was obvious that Kamanis had no intention to refund the principal amount. In the circumstances, having regard to the Supreme Court decision in Shoorji Vallabhadas & Co.'s case (supra), and other decisions on the issue the Commissioner (Appeals) was fully justified in holding that no income by way of interest accrued to the assessee during the previous years. Lastly, the counsel placed reliance on the Calcutta High Court decision in Naskarpara Jute Mills Co. Ltd.'s case (supra) for the purpose of showing that interest, if at all, will accrue in favour of the assessee upon the date of the filing of the suit and that thereafter as laid down by Section 34 of the Code of Civil Procedure, 1908 whether or not and to what extent the assessee will be entitled to the interest will depend upon the discretion of the Court. Accordingly, it is urged that interest, after the filing of the suit in the High Court, i.e., 19-2-1976 will not accrue to the assessee at all, until the decree has been passed by the Hon'ble High Court in favour of the assessee. In response to a query from the Bench, it has been fairly admitted by Shri Kapadia that the principal as well as the interest has been received by the assessee in the year 1982 in terms of the High Court decree dated 23-4-1984 and that the whole amount of interest has been offered and taxed for the year 1982-83. It is also stated that interest up to the date of the suit, i.e., 19-2-1976 amounts to Rs. 46,913.
7. In reply, the departmental representative has relied on the comments of the learned commentator Shri Palkhivala, in his treatise at page 872, for the purpose of showing that the change in the method of accountancy can be allowed if it is a bona fide change and that too if it is not too frequent. As regards real income theory propounded by the assessee's counsel, the departmental representative has relied on the Gujarat High Court decision in the case of Udayan Chinubhai v. CIT  111 ITR 584 and the Rajasthan High Court decision in CIT v.Vijay Laxmi Trading Co. Ltd.  147 ITR 372, where a contrary view is stated to have been taken.
8. We have heard the parties and have gone through the facts and relevant material on record and the cases relied upon by the parties.
We consider it desirable to refer to clause 12 which reads as under: For the due performance of the obligations and/or undertaking given by the distributors herein and for carrying out the terms hereof, the distributors hereby agree and have undertaken to deposit and keep deposits with the company directly or through their nominees a sum of Rs. 10 lakhs (Rs. ten lakhs only) during the continuance of this agreement.
The company shall pay interest on the amount deposit at 12 per cent per annum to the distributors, such interest being payable every half yearly on the 30th June and 31st December every year. The sum of Rs. 10 lakhs will be refunded by the company to the distributors within three months of termination of this agreement for any reason whatsoever in three equal monthly instalments provided, however, that if at the time of termination of this agreement** any amount due from any party for the products sold which is in dispute and is not forthcoming then such amount shall be kept in **the company till it is received from the party. The repayment of the said deposit and interest shall be personally guaranteed by Shri H.R. Kamani and Shri C.R. Kamani. **Illegible.
It is evident from the above clause that interest is payable on the amount of deposit at the rate of 12 per cent per annum every half yearly on 30th June and 31st December and that the deposit is to be refunded by Kamani to the assessee within three months of the termination of the agreement in three equal monthly instalments. On a plain reading of the agreement, we are of the view that there is no stipulation whether the amount of deposit will carry any interest after the date of the termination of the agreement. We also find that Section 34 of the Civil Procedure Code provides for three situations as regards the interest to be decreed, viz., (i) interest prior to suit, (ii) interest pending during the suit, i.e., up to the date of the decree, and (iii) future interest, i.e., interest after the decree. While the interest prior to the suit is governed as per the contract, if any, the interest for the period during which the suit is pending is to be awarded in the discretion of the Court and so is the case with regard to the future interest. In our this view, we are supported by the Calcutta High Court decision in Naskarpara Jute Mills Co. Ltd.'s case (supra). In the circumstances, during the pendency of the suit, it will have to be held that interest cannot be said to accrue in favour of the assessee, i.e., for the period after the suit is filed.
9. In this view of the matter, for the period from 19-2-1976 to 30-6-1976 relevant for the assessment year 1977-78 and for 1-7-1977 to 30-6-1977 relevant for the assessment year 1978-79, we have no difficulty in holding that interest cannot be said to accrue in favour of the assessee.
The fact that finally the full interest has been awarded by the High Court by its decree dated 28-4-1981 only means that the interest has for the period of pendency of the suit accrued on the date of the decree and nothing more. In this view of the matter, it is not really necessary for us to refer to the concept of real income in this case.
10. This takes us to the question whether interest for the period from 1-7-1975 to 18-2-1976 has or can be said to have accrued in favour of the assessee. Here again, as stated by us earlier, clause 12 does not, as such, provides for charging of interest after the termination of the distributorship agreement. The agreement terminates in terms of the notice on and from 18-11-1975. The notice of termination has been given by the assessee on 18-7-1975. Kamanis have filed a counter claim for the recovery of Rs. 3,98,000 and odd, in these circumstances, it is reasonable to hold that interest has not accrued to the assessee even for this period. It may not be out of place to mention that we also find substance in the assessee's submissions, viz., that strictly speaking, the assessee was not following the mercantile system of accountancy in respect of this transaction. These entries in the books have been made not at the end of the year, which would be a case if a person is following the mercantile system of accountancy scrupulously.
In the case of the assessee's interest, entries are made on the receipt of credit notes which have been received half yearly as stipulated in clause 12. Therefore, the interest will not accrue to the assessee even on this score. For these and other reasons given by the Commissioner (Appeals) with which we agree, we hold that the appellate authorities were justified in deleting the addition made by the [TO on account of accrued interest in respect of outstanding amounts deposited with Kamanis.
11 to 13. [These paras are not reproduced here as they involve minor issues.]