J.V. Gupta, J.
1. At the instance of the Revenue, the following two questions have been referred by the Income-tax Appellate Tribunal, Amritsar Bench (hereinafter called the 'Tribunal'), under Section 256(1) of the I.T. Act, 1961, vide its order dated March 18, 1976 :
'1. Whether, on the facts and in the circumstances of the case, the expenditure of Rs. 83,691 by way payment of interest by the assessee to the Kapoor group, was an admissible deduction under Section 37 of the Income-tax Act, 1961
2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sum of Rs. 50,044 was a notional receipt and hence was not liable to be assessed in the hands of the assessee during the assessment year 1970-71 ?'
2. The brief facts giving rise to these questions are these. The asses-see-firm known as M/s. N. D. Radha Kishan & Co., Pathankot, runs a fleet of passenger buses. This firm was formely constituted by two groups, namely, Kapoor group and Sethi group. A civil suit was filed by the Kapoor group in the High Court of Jammu and Kashmir against the Sethi group in the year 1968 for the rendition of accounts and dissolution of the firm. The High Court passed a preliminary decree for dissolution of the partnership and rendition of accounts, vide order dated March 3, 1969. In pursuance of the preliminary decree, a Commissioner was proposed to be appointed to go into the accounts of the dissolved partnership to enable the court to pass a final decree in the case. At that stage, a compromise was arrived at between the parties and by virtue of a compromise deed, dated April 21, 1969, it was agreed that a sum of Rs. 9,47,500 would be paid by the defendants (Sethi group) to the plaintiffs (Kapoor group) and that the defendants would be liable to pay interest on this amount at 15 per cent. per annum. Clause (iv) of the said compromise deed reads as under :
'That the remaining amount of Rs. 9,47,500 will be paid by defendants (Sethi group), in the proportions mentioned below. The defendants will be liable to pay interest on this amount at 15 per cent. per annum with quarterly rests.'
3. A sum of Rs. 63,691 was paid by way of interest by the newly constituted firm (which came into existence as a result of the partnership deed dated March 13, 1970), that is, the assessee, and the same was claimed as admissible deduction under Section 37 of the Act. The ITO disallowed the said claim on the ground that this liability was to be borne by the Sethi group and not by the newly constituted firm.
4. On appeal before the AAC, the assessees submitted that since all the assets and liabilities of the erstwhile firm were taken over by the newly constituted firm and its partners had acknowledged the liability pertaining to the Sethi group, the claim for interest should be fully allowed in the assessment of the firm. It was also pointed out that the amount of interest paid to the outgoing partners was debited to the individual partner's account in view of the fact that all the new partners had duly acknowledged the liability of Rs. 9,47,500 and interest thereon, which was payable to the Kapoor group. The AAC accepted the claim of the assessee and deleted the addition of Rs. 83,691 made by the ITO.
5. Aggrieved against the order of the AAC, the Revenue filed an appeal before the Tribunal. The order of the AAC was upheld by the Tribunal and it was held-:
' After hearing the learned representatives of the parties and going through the records, we are of the opinion that the Department has nocase. We have gone through the partnership deed dated 13-3-70, executed by the partners of the newly constituted firm and find from the preamble and Clause (ii) of the said partnership deed that the new firm took over the business of the erstwhile firm with effect from 1-4-69 as a going concern and all the present partners of the newly constituted firm had accepted the liability in respect of the old firm. Thus, the liability in respect of amount of Rs. 9,47,500 and interest thereon payable to the Kapoor group became the liability of the newly constituted firm and, in these circumstances, the assessee was entitled to claim the deduction of the interest paid to the Kapoor group. Further, the unpaid amount which was payable to the outgoing partners by virtue of the compromise deed dated 21-4-1969 in fact represented capital borrowed for the purpose of the business of the assessee and hence interest on this capital borrowed is an allowable deduction under Section 37 of the Income-tax Act, 1961. We are, therefore, of the opinion that the Appellate Assistant Commissioner was quite justified in deleting the disallowance of Rs. 83,691 as interest paid to the outgoing partners. The contention of the Department is, accordingly, rejected. '
6. The learned counsel for the Revenue contended that by virtue of the partnership deed dated March 13, 1970, annex. D, by which the new partnership was constituted and came into being with effect from April 1, 1969, the assets of the old firm were never transferred to the newly constituted firm, that is, the assessee. According to him, there is no stipulation in the said partnership deed for taking over the obligations of the Sethi group under the compromise decree and the new partners were there for the running of the business only and they were not partners in the assets of the firm.
7. We are unable to agree with this contention of the learned counsel. It has been categorically found by the Tribunal that all the present partners of the newly constituted firm had accepted the liability in respect of the old firm and thus the liability in respect of the amount of Rs. 9,47,500 and interest thereon payable to the Kapoor group became the liability of the newly constituted firm.
8. Moreover, what is now being contended on behalf of the Revenue was never the case set up before the Tribunal. Apart from that, from a perusal of the partnership deed, annex. D, we find that the parties had taken over the running business of the erstwhile firm as on April 1, 1969. Thus, what was taken over by the assessee-firm was the whole business including the assets and liabilities of the old firm. In this view of the matter, the answer to question No. 1 is in the affirmative, i.e., against the Revenue.
9. As regards the second question, the facts are that the written down value of the assets of the old firm as on March 31, 1969, which were takenover by the newly constituted firm as per the books of account, amounted to Rs. 5,05,019. However, in terms of the compromise deed dated April 21, 1969, these assets were revalued at Rs. 10,48,198 as on March 31, 1969. The difference of Rs. 5,43,179 was initially debited to the accounts of the Sethi group of partners as, according to the assessee, the incoming partners did not agree to take over the assets at their book value. By passing the above debit entry to the accounts of the Sethi group of partners, their accounts showed debit balances and, accordingly, the firm charged interest amounting to Rs. 50,044 from these partners and the above interest was disclosed as income in the return of income filed originally. Later on, by a resolution dated August 14, 1971, the entries to the debit of the Sethi group were reversed by passing two entries at pp. 43 and 44 of the journal. The effect of the reversed entry was that the accounts of the Sethi group were credited with a sum of Rs. 5,43,179 and the corresponding debit to the extent of Rs. 2,94,981 was made to the fixed assets account and the balance sum of Rs. 2,48,199 was debited to M/s. N. D. Radha Kishan & Co.'s suspense account. As a result of the reversal of the said entries, the interest charged from the Sethi group earlier amounting to Rs. 50,044 was withdrawn and in the revised return, the assessee reduced its income from interest by a sum of Rs. 50,044. The ITO, however, added back the sum of Rs. 50,044 towards the total income of the assessee as he took the view that no evidence was placed on the record to show that the new partners had agreed to reverse this entry from Sethi group to the books of account of the firm.
10. On appeal, the AAC deleted the additions made by the ITO on the ground that the said sum of Rs. 50,044 was a notional receipt and could not be assessed to tax.
11. Aggrieved against the finding of the AAC, the Revenue contested this finding in appeal before the Tribunal, which upheld the order of the AAC with the following observations :
'Before us, the learned representative of the Department has submitted that it is not clear at what point of time and (sic) entries were reversed and the interest charged earlier from the partners was credited back to their capital account. It was pointed out that in the original return, the income from interest was shown and, hence, the reversal of the entries made after the close of the year would not entitle the assessee to claim the deduction. In our opinion, the objection of the learned departmental representative is of no consequence. The mere passing of an entry does not mean that income had accrued to the assessee. Since the assessee did not derive any income from an outside source, it was entitled to reverse the entry at any time retrospectively before the completion of the assessment for the relevant year. In these circumstances, the Appellate Assistant Commissioner was quite justified in deleting the addition of Rs. 50,044 made by the Income-tax Officer towards the total income of the assessee. The Department fails.'
12. The learned counsel for the Revenue contended that the method of accounting was mercantile and, therefore, if once the income from interest was shown it could not be reversed after the close of the year, and thus it would not entitle the assessee to claim the deduction. In support of this contention, he relied upon Morvi Industries Ltd. v. CIT : 82ITR835(SC) and CIT v. P. Nataraja Sastri : 104ITR245(Mad) .
13. On the other hand, the learned counsel for the assessee submitted that since there was no agreement between the partners of the newly constituted firm in the beginning with respect to the written down value and, therefore, there was some misunderstanding as regards this amount, the entry was consequently reversed subsequently by way of the resolution dated August 14, 1971. Moreover, according to the learned counsel, the mere entry in the books of account is not income as the same does not accrue hypothetically. In support of this contention, he relied upon the judgments of this court in CIT v. Ferozepur Finance (P.) Ltd. and Shiv Parkash Janakraj & Co. (P.) Ltd. v. CIT .
14. After hearing the learned counsel for the parties, we do not find anymerit in the contention raised on behalf of the Revenue. Since the assesseedid not derive any income from an outside source, it was entitled toreverse the entry at any time, retrospectively, before the completion of theassessment for the relevant year. In Ferozepur Finance (P.) Ltd.'s case, this court has taken the view thatincome-tax is levied on income, whether the accounts are maintained onmercantile system or on cash basis. If income does not result at all, therecannot be a levy of tax. Even if an entry of hypothetical income be madein the books of account, where the income does not result at all, as thereis neither accrual nor receipt of income, no tax can be levied. Thus, the Tribunal was justified in holding that, on the facts and inthe circumstances of the case, the sum of Rs. 50,044 was a notional receiptand hence was not liable to be assessed in the hands of the assessee duringthe assessment year 1970-71. Therefore, the answer to this question isalso in the affirmative, i.e., against the Revenue.
15. The reference stands answered accordingly with costs.
S.P. Goyal, J.
16. I agree.