M. R. SHARMA J. - Since common questions of law and fact are involved in Income-tax References Nos. 93 and 94 of 1974, 5, 16, 53, 68, 109, 110 of 1975, and 3 to 6 of 1976, they are being disposed of by one judgment.
For facility of reference, facts giving rise to Income-tax Reference No. 5 of 1975 are briefly stated as under : At the instance of M/s. Shiv Parkash Janak Raj & Co. (P.) Ltd., Amritsar (hereinafter referred to as 'the assessee-company'), the Income-tax Appellate Tribunal, vide its order dated October 7, 1974, referred the following questions of law under section 256(1) of the Income-tax Act, 1961 (hereinafter called 'the Act'), for our opinion :
'(i) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest for the assessment year 1971-72, had already accrued to the assessee on October 31, 1970, under the mercantile system of accountancy ?
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the subsequent relinquishment of interest by a resolution dated November 24, 1970, did not affect the tax liability of the assessee on accrual basis ?'
The facts on which this controversy has arisen may briefly be stated as under. The partners of the firm known as M/s. Shiv Parkash Janak Raj & Co. (hereinafter referred to as 'the firm') are shareholders of the assessee-company. The assessee-company had advanced a loan to the firm for which it charged interest to the tune of Rs. 25,048 for the assessment year 1966-67 and Rs. 25,843 for the assessment year 1967-68. By a resolution dated November 24, 1970, the assessee-company decided not to charge interest from the firm for the assessment year 1971-72, relevant to the accounting period ending on October 30, 1970. The said resolution reads as under :
'The chairman informed the board that M/s. Shiv Prakash Janak Raj & Co., Bombay, which was Rs. 2,10,233.44 to the company is in a very tight position and has approached the company to waive the interest on the amount due from them for the year ended 31st October, 1970. He also informed the board that all the directors are interested in the said firm as partners. The matter was discussed by the board and it was resolved that no interest be charged from M/s. Shiv Parkash Janak Raj & Co., Bombay, on the amount due from them for the year ending 31st October, 1970.'
The Income-tax Officer who was seized of the case observed that the loans in question were interest-bearing loans and since the assessee-company had relinquished the interest without any commercial consideration and since the directors and shareholders of the assessee-company were interested in the firm, it was a case of collusion to evade the tax liability. He therefore, added a sum of Rs. 31,565 to the income of the assessee-company under the head 'Interest' at the rate of 15% per annum.
On appeal, the Appellant Assistant Commissioner observed that the resolution to waive the interest was passed on November 24, 1970, i.e., after the end of the accounting period and since the assessee-company after followed the mercantile system of accountancy, the interest had already accrued to the assessee before it was waived. On this basis, he upheld the addition of Rs. 18,941 to the income of the assessee-company under the head 'Interest' at 9% per annum.
Feeling aggrieved, the assessee-company filed a second appeal before the Income-tax Appellate Tribunal which observed that even though no entries were passed in respect of the amount of interest either in the account books of the assessee-company or of the firm the loans were interest-bearing, that interest at the rate of 9% had been charged on previous occasions, that the resolution dated November 24, 1970, was passed after the expiry of the relevant accounting period, that the assessee-company followed the mercantile system of accountancy, and that the relinquishment of interest was not for commercial purposes and as such the interest had been relinquished after it had already accrued to the assessee-company.
It has been argued by the learned counsel for the assessee-company that income-tax can be levied only if the income accrues or is received in the case of interest-bearing loans. There was no bar against a lender of money to forgo interest at any time. In the instant case, the agreement under which the loan was advanced was not reduced into writing and as such there is no fixed date for the payment of interest. On the facts found by the Tribunal, neither the interest had in fact been paid to the assessee-company nor had it made the relevant entries in its account books and merely because it adopted the commercial system of accounting, it could not be burdened with tax liability.
On behalf of the revenue, it has been argued that interest once accrued cannot be written off because no assessee can be allowed to indulge in charities at the cost of the revenue. Further, the interest accrues from day to day and in any case it accrues at the end of the year of accounting. In this context, the fact that the assessee-company adopted the mercantile system of accounting was relevant for determining whether the interest had accrued to it or not.
In support of his submissions, Mr. Awasthy relied upon Morvi Industries Ltd. v. Commissioner of Income-tax : 82ITR835(SC) , in which it was observed as under :
'The income can thus be said to accrue when it becomes due. The postponement of the date of payment was a bearing only in so far as the time of payment is concerned, but it does not affect the accrual of income. The moment the income accrues, the assessee gets vested with the right to claim that amount even though it may not be immediately. There also arises a corresponding liability of the other party from whom the income becomes due to pay that amount. The further fact that the amount of income is not subsequently received by the assessee would also not detract from or efface the accrual of the income, although the non-receipt may, in appropriate cases, be a valid ground for claiming deductions. The accrual of an income is not to be equated with the receipt of the income..........
It is well known that the mercantile system of accounting differs substantially from the cash system of book-keeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits; whereas under the mercantile system, credit entries are made in respect of amounts due immediately they become legally due and before they are actually received; similarly, the expenditure items for which legal liability has been incurred are immediately debited even before the amounts in question are actually disbursed.'
Mr. Awasthy further submitted that there was no evidence to show that the agreement of loan had been modified or rescinded during the relevant accounting period and the interest should be deemed to have been accrued to the assessee-company on the day when it was, in accordance with its normal business practice, obliged to make the debit entries.
The submissions made by Mr. Awasthy are not wholly without force but we are of the view that the decision of the cash stands concluded against the revenue by a recent judgment of their Lordships of the Supreme Court in Commissioner of Income-tax v. Birla Gwalior (P.) Ltd. : 89ITR266(SC) . In that case, the assessee-respondent was a managing agent of the National Bearing Co. Ltd. and Gwalior Rayon & Silk Manufacturing Co. As managing agent of the former company it was entitled to receive a commission of 12 1/2% per cent. on the net profits of the managed company together with a sum of Rs. 18,000 as office allowance. In the case of the latter company it was entitled to get an office allowance of Rs. 30,000 per year in addition to the agreed managing agency commission. In the relevant accounting years the assessee gave up the managing agency commission due from both the managed companies. It also gave up the office allowance due from Gwalior Rayon & Silk Manufacturing Company. The question arose whether the amounts given up could be regarded as income of the managing company or not. Regarding the amount of Rs. 30,000 representing the office allowance, it was held by the Tribunal that because of the sacrifices made by the assessee-company, the finances of the managing company improved subsequently as a result of which the assessee-company was able to earn more profits in the later years. On the the basis of this finding, the court held that the Tribunal was fully justified in coming to the conclusion that the expenditure incurred came within the scope of section 10(2)(xv) of the Act. With regard to the other matter, the court observed as under (page 270) :
'Now turning to the question regarding giving up of the commission, as mentioned earlier, the assessee was maintaining its accounts on the basis of the mercantile system. Its accounting year was the financial year. It gave up the commission after the end of the financial year. On the basis of these facts it was contended on behalf of the revenue that the commission had accrued before it was given up. Hence, it cannot be said that the assessee had not earned the commission in question. Therefore, the assessees case cannot be considered under section 10(1). We are unable to accept this contention as correct. As mentioned earlier, no due date was fixed for the payment of the commission under the managing agency agreements. The commission receivable could have been ascertained only after the managed company made up its accounts. The assessee had given up the commission even before the managed company made up its accounts. Hence, the mere fact that the assessee-company was maintaining its accounts on the basis of the mercantile system cannot lead to the conclusion that the commission had accrued to it by the end of the relevant accounting year.'
As observed earlier, no interest had actually been paid to the assessee-company nor had it made any debit entries in its account books. No date was fixed in the agreement of loan regarding the payment of interest. In these circumstances, even if the assessee-company had adopted the mercantile system of accounting, it cannot be said that income from interest had actually accrued to it on October 31, 1970.
Mr. Awasthy then relied upon Commissioner of Income-tax v. Dr. Sham Lal Narula , for the proposition that where the rate of interest is specified, it must be deemed to accrue at the end of the year. That case is also distinguishable. Because the assessee in that case had been paid accumulated interest on the amount awarded by the Land Acquisition Collector as compensation to him, and the Division Bench clearly observed that the interest on the compensation amount was paid to the assessee in order to compensate for the loss of income which would have accrued to him year after year. The analogy of that case cannot be extended to the case of a loan advanced under an oral agreement.
For the reasons mentioned above, we answer the question in favour of the assessee-company and against the revenue. The parties are, however, left to bear their own costs.