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Commissioner of Income-tax Vs. Kerala Financial Corporation Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKerala High Court
Decided On
Case NumberIncome-tax Reference Nos. 126 to 127 of 1979 and 238 of 1982
Judge
Reported in(1985)47CTR(Ker)286; [1985]155ITR246(Ker)
ActsIncome Tax Act, 1961 - Sections 116
AppellantCommissioner of Income-tax
RespondentKerala Financial Corporation Ltd.
Appellant Advocate P.K. Ravindranath Menon, Adv.
Respondent Advocate Mathews P. Mathew, Adv.
Cases ReferredNavnit Lal C. Javeri v. K.K. Sen
Excerpt:
.....hybrid system of accounting - assessee earned interest income on loan - department charged tax on accrual basis - whether tax be charged on accrual basis or receipt basis - once income charged to tax same would not be again taxed - in hybrid system of accounting same principal of law followed - in view of legal position department can impose tax on interest on accrual basis - decision of department justified. - - the assessee in such cases can, under section 36(1)(vii), claim an allowance in respect of the unrealised income, as bad debt. it may at best be said that the assessee has introduced a change in the modality of accounting. 279 and 280 of 1979. however, we would like to refer to some of those authorities which clinch the issue. ie it ultimately writes off such interest, it..........to be the same and, therefore, the interest income from 'such loans' was liable to be taxed on 'accrual basis'. in support of its contention, the department relied on three decisions on this court catholic bank of india ltd. v. cit [1964] klt 653, state bank of travancore v. cit : [1977]110itr336(ker) and the unreported decision state bank of travancore v. cit (i.t.r. nos. 27, 28 and 29 of 1971). the department also refuted the contention of the assessee that the issue involved in the case was directly covered by a circular of the c.b.d.t. (annex. b).8. the questions referred to this court have to be tackled in the light of the principles of law we propose to state immediately.9. under section 5 of the act, income is charged on either 'accrual or arisal basis' or 'deemed accrual or.....
Judgment:

Radhakrishna Menon, J.

1. The Income-tax Appellate Tribunal, Cochin Bench, at the instance of the Revenue, has referred the following questions to this court. In I.T.R. Nos. 126 and 127 of 1979, the question referred is:

'Whether, on the facts and in the circumstances of the case, Rs. 2,31,591 credited to the interest suspense account for the year ended March 31, 1973, and Rs. 11,65,621 credited to the interest suspense account for the year ended March 31, 1976, should not be brought to tax for the assessment years 1973-74 and 1976-77, respectively ?'

and in I.T.R. No. 238 of 1982, the question is :

'Whether, on the facts and in the circumstances of the case, Rs. 17,02,005 credited to the 'interest suspense account' for the year ending March 31, 1977, should not be brought to tax for the assessment year 1977-78 ?'

2. These references arise from the assessment proceedings relating to the years of assessment 1973-74, 1976-77 and 1977-78.

3. These issues now before us are identical to the issues we have already dealt with while answering the question in I.T.Rs. Nos. 279 and 280 of 1979 [CIT v. Kerala Financial Corporation, : [1985]155ITR228(Ker) ] which related to the assessment years 1974-75 and 1975-76. The facts stated in that judgment disposing of these cases are not repeated here. The facts which are peculiar to these references alone are stated hereunder:

In the year of assessment 1973-74 in making the original assessment, the ITO had not brought to tax the interest credited to the 'suspense account.' He, however, reopened the assessment and brought to tax the interest aforesaid on the finding that inasmuch as the assessee was following mercantile system of accounting, the income must be held to have accrued during the relevant period. For the year of assessment 1976-77, the interest credited to the 'suspense account' had been brought to tax in the original assessment itself. Similarly for the year 1977-78 also such interest had been brought to tax in the assessment. The appellate authority accepted the case of the assessee that such interest is not exigible to tax and accordingly directed deletion of the same from the total taxable income. On further appeal by the Revenue, the Appellate Tribunal following its earlier order in appeals, relating to assessments for the assessment years 1974-75 and 1975-76, held that such interest is not includible in the total taxable income. The appeals accordingly were dismissed. The questions now before us arise from the said orders of the Tribunal.

4. Following our judgment in I.T.Rs. Nos. 279 and 280 of 1979 [CIT v. Kerala Financial Corporation, : [1985]155ITR228(Ker) ] we would answer the questions in favour of the Revenue and against the assessee. However, taking into account the importance of the questions, we shall highlight certain vital aspects of the matter.

5. The only case the assessee pressed before the Tribunal was this. Under Section 145 of the I.T. Act, 1961 (for short 'the Act'), income assessable to tax under the head 'Profits and gains of business' requires to be computed in accordance with the method of accounting regularly employed by the assessee. It was pointed out that the assessee was free to change the method of accounting and adopt a new method provided the change was made bona fide, without the intention of evading tax, and that the changed method of accounting was regularly followed. It was accordingly submitted that the change in the method of accounting adopted by the assessee with effect from March 31, 1972, in respect of such loans which had not been recovered for three years, should have been accepted by the assessing authority.

6. The facts highlighted by the assessee in this regard were that the assessee since March 31, 1972, was crediting the interest on such loans in the 'interest suspense account' as directed by the Reserve Bank (annex. A) instead of crediting it in the 'interest account' ; that the assessee while crediting the interest in the 'interest suspense account' used to make corresponding debit entries also in the account of the respective debtors.

7. The Department contended that the method of accounting, however, continued to be the same and, therefore, the interest income from 'such loans' was liable to be taxed on 'accrual basis'. In support of its contention, the Department relied on three decisions on this court Catholic Bank of India Ltd. v. CIT [1964] KLT 653, State Bank of Travancore v. CIT : [1977]110ITR336(Ker) and the unreported decision State Bank of Travancore v. CIT (I.T.R. Nos. 27, 28 and 29 of 1971). The Department also refuted the contention of the assessee that the issue involved in the case was directly covered by a circular of the C.B.D.T. (annex. B).

8. The questions referred to this court have to be tackled in the light of the principles of law we propose to state immediately.

9. Under Section 5 of the Act, income is charged on either 'accrual or arisal basis' or 'deemed accrual or deemed arisal basis' or 'receipt basis' or 'deemed receipt basis.'

10. In CIT v. Shoorji Vallabhdas & Co. : [1962]46ITR144(SC) , the Supreme Court explained this aspect thus (p. 148):

'.........the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt........'

11. The meaning of these terms has succinctly been stated by the Supreme Court in Seth Pushalal Mansinghka (P.) Ltd. v. CIT : [1967]66ITR159(SC) . It reads (p. 164):

'The words 'accrue' and 'arise' do not mean actual receipt of the profits or gains. Both these words are used in contradistinction to the word 'receive' and indicate a right to receive.'

12. To the same effect are the following decisions of the Supreme Court in Indermani Jatia v. CIT : [1959]35ITR298(SC) and Moyvi Industries Ltd. v. CIT : [1971]82ITR835(SC) .

13. Thus, under Section 5 of the Act, profits are chargeable when they accrue or arise or are deemed to have accrued or arisen or are received or deemed to have been received. Explanation 2 to this section embodies the rule that if an income is charged on accrual basis, the same shall not again be subjected to tax on 'receipt basis'.

14. The system of accounting adopted by an assessee is just an aid to compute the income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources'. Section 145 of the Act deals with the 'system of accounting'. The section envisages two main methods of accounting. They are the mercantile system and cash system. There is yet another system of accounting. That is called the hybrid or heterogeneous system. Under the cash system, the assessee maintains a record of actual receipts and actual payments. Under the mercantile system, the accounts are maintained according to what is known as 'the mercantile accountancy system' or 'the books profits system of accountancy' or the 'complete double entry book-keeping'. Under this system, it is unnecessary to verify whether the assessee has actually received the income or the expenditure has actually been paid while computing the chargeable income. The distinguishing feature of this system of accountancy when compared to the cash system is that it brings into credit what is legally due and before it is actually received. Similarly, it brings into debit the expenditure before it is actually paid. In the hybrid or heterogeneous system, certain elements and incidents of mercantile and cash systems are combined and, therefore, the principles enunciated above equally apply to this mode of accounting also. This view is consistent with the dictum of the Supreme Court discernible from the decision in Keshav Mills' case (Keshav Mills Ltd. v. CIT : [1953]23ITR230(SC) ) and in Krishnaswami Mudaliar's case (CIT v. Krishnaswamy Mudaliar : [1964]53ITR122(SC) ). In Keshav Mills' case, the Supreme Court has stated thus (p. 239):

'The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of look-keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The profits or gains of the business which are thus credited are not realised but having been earned are treated as received though in fact there is nothing more than an accrual or arising of the profits at that stage. They are book profits. Receipt being not the sole test of chargeability and profits and gains that have accrued or arisen or are deemed to have accrued or arisen being also liable to be charged for income-tax, the assessability of these profits which are thus credited in the books of account arises not because they are received but because they have accrued or arisen.'

15. Section 145, in other words, is only an enabling provision to effectuate the charge. To hold otherwise would be to take chargeable profits/income outside the purview of the charging section, although such profits/income have either accrued or arisen or received in the previous year. This section, being a machinery provision, shall not qualify or control Section 5, as per the scheme of the Act and is but an extension of Section 4, the charging provision. Section 5 brings within the fold of chargeable total income, all income of a person which, subject to the other provisions of the Act, accrues or arises or is deemed to accrue or arise or is received or is deemed to have been received in the previous year. 'Subject to the provisions of this Act' in the section only indicates the ambit of taxation. It means that in computing the chargeable income, such of those provisions which exempt income from tax and also the provisions contained in Chapter IV of the Act, must be considered and be given their full effect. None the less, Section 145 provides that income chargeable under the heads 'Profits and gains of business or profession '(Section 28) and 'Income from other sources' (Section 56) shall be computed in accordance with the method of accounting, regularly employed by the assessee. If the assessee keeps the books of account on mercantile basis, profits earned would be taxable on accrual basis, i.e., when an assessee acquired a right to receive it even if the profit earned is unlikely to be realised. The assessee in such cases can, under Section 36(1)(vii), claim an allowance in respect of the unrealised income, as bad debt. But as the Supreme Court held in CIT v. Thiagaraja Chetty and Co. : [1953]24ITR525(SC) : 'The computation of the profits whenever it may take place cannot possibly be allowed to suspend their accrual.'

16. Considered in the light of the above principles of law, we have no hesitation to conclude that the finding of the Tribunal that the disputed amounts are not exigible to tax is not sustainable. It is not the case of the assessee that it was not crediting the interest accruing on these loans in the account; on the other hand, what the assessee was doing was, in the words of the Tribunal, 'interest accruing on loans which has not been realised for three years was credited in such account after making debit entries in the accounts of the debtors'. 'Such account' means 'the interest suspense account'.

17. From the facts found, it is clear that the assessee had not changed the method of accounting. It continued to maintain the mercantile system of accounting. This mode of accounting adopted by the assessee is in no way different from the mercantile system of accounting. It is not as if the assessee was not aware of the difference between the mercantile system of accounting and cash system of accounting. In this context, it is relevant to note the following findings of the Tribunal:

'But in respect of advances for the recovery of which suits have been filed and decrees have been obtained, the assessee has been crediting interest only as and when the same has been received.'

18. The change thus adopted by the assessee under no circumstances could be said to be a change in the method of accounting. It may at best be said that the assessee has introduced a change in the modality of accounting.

19. Virtually, the questions involved in the cases are covered by the decisions of this court in Catholic Bank [1964] KLT 653 and State Bank of Travancore : [1977]110ITR336(Ker) . The distinction drawn on facts by the Tribunal to distinguish the above decisions of this court, in the circumstances of the case, is no distinction at all. The Tribunal has thus misdirected itself in law. The counsel for the Revenue, therefore, is right in his submission that the findings of the Tribunal are liable to be reviewed. The assessee, despite the change, according to it a change introduced in the method of accounting, continued to credit the interest accruing on loans which had not been realised for three years in the account after making debit entries in the accounts of the debtors. In short, the assessee was accounting this receipt on an 'accrual basis' and not on 'cash basis'. The disputed amounts, therefore, are liable to be included in the chargeable total income of the assessee on accrual basis although the same were credited in a 'suspense account'.

20. Confronted with the situation brought about by the decision of this court in Catholic Bank's case [1964] KLT 653 and the State Bank of Travancore's case : [1977]110ITR336(Ker) , the learned counsel for the assessee approached the issue from a different angle. He submitted that the above decisions can be distinguished and in expansion of this argument raised three grounds. They are:

(i) This court in the earlier decisions mentioned above was not called upon to consider the question whether there was a change in the method of accounting. In fact in the said decisions the finding was that the asses-see had continued the mercantile system of accounting.

(ii) The applicability of the concept of 'real income' was not considered by this court, assuming there was no change in the method of accounting.

(iii) The availability of the Circular of C.B.D.T. (annexure B) exempting the income (i.e., interest on sticky amounts) was not considered by this court.

21. Since we have already dealt with the first ground, we shall straightaway proceed to deal with the other grounds.

22. The second ground, the learned counsel submits, really clinches the issue. He submits that after the alleged change in the method of accounting, no interest can be said to have accrued, arisen or been received by the assessee. Under the income-tax law, there is no 'hypothetical income' or 'hypothetical accrual' or 'hypothetical arising' or 'hypothetical receipt.' He submitted that there cannot be a tax if income has not resulted at all. The position is not different even in a case where an entry is made in an account about a 'hypothetical income' which does not materialise. If income has not resulted at all, it is obviously neither accrual nor receipt even in spite of the fact that an entry has been made in the account, the learned counsel submits. In the case on hand, income has not materialised although the assessee has made entries about the same in the 'suspense account.' The accrual in such circumstances can only be a hypothetical accrual, he further submits. The income sought to be assessed, therefore, is not exigible to tax as it has not materialised.

23. In support of the above argument, the counsel called our attention to a number of authorities. All relevant authorities have already been dealt with by us in our judgment disposing of I.T.R. Nos. 279 and 280 of 1979. However, we would like to refer to some of those authorities which clinch the issue. They are : H.M. Kashiparekh & Co. Ltd. v. CIT : [1960]39ITR706(Bom) , CIT v. Shoorji Vallabhdas & Co. : [1962]46ITR144(SC) ; Poona Electric Supply Co. Ltd. v. CIT : [1965]57ITR521(SC) ; Morvi Industries Ltd. v. CIT : [1971]82ITR835(SC) and CIT v. Birla Givalior (P.) Ltd. : [1973]89ITR266(SC) .

24. In Birla Gwalior (P.) Ltd.'s case : [1973]89ITR266(SC) , the Supreme Court reviewed the case law pertaining to the concept of 'real income.' This was a case where the assessee had given up/forgone a portion of the managing agency commission. The question arose whether the commission forgone is liable to be included in the taxable income of the assessee. No due date for payment of commission had been stipulated in the agreement. Referring to this aspect of the case, the Supreme Court held (p. 270);

'......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.'

25. Referring to Kashiparekh & Co. Ltd.'s case : [1960]39ITR706(Bom) , this is what the Supreme Court has said (p. 271).

'The accrual of the commission, the making up of the accounts, the legal obligation to give up part of the commission, and the forgoing of the commission at the time of making up of the accounts were not disjointed facts : there was a dovetailing about them which could not be ignored. The real income of the assessee was Rs. 27,644 and the amount of Rs. 97,000 forgone by the assessee could not be included in the real income of the assessee for the accounting year.'

26. Dealing with Mom Industries case : [1971]82ITR835(SC) , this is what is stated in the judgment (p. 273):

'This court came to the conclusion that the amounts in question were due on December 31, 1955 and 1956, though payable at a later date ; consequently those amounts had accrued long before they were given up and the giving up of the same did not come within the scope of Section 10(1).'

27. After noticing Shoorji Vallabhdas and Co.'s case : [1962]46ITR144(SC) , the Supreme Court concluded the discussion thus (p. 273):

'Hence it is clear that this court in Morvi Industries case : [1971]82ITR835(SC) , did emphasise the fact that the real question for decision was whether the income had really accrued or not. It is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income.'

28. The following principles emerge from the above decisions: (1) the assessee had given up a portion of their commission ; in certain cases, the giving up was after the accrual, (2) the mercantile system followed by an assessee has no bearing on the accrual of the income, (3) hypothetical income based on hypothetical accrual is not includible in the total chargeable income of an assessee, and (4) income given up on the ground of commercial expediency, but before accrual, is not chargeable income.

29. Briefly stated, the ratio decidendi of these decisions is that the income given up or forgone by an assessee on the basis of bilateral agreements or under provisions of statutes but before its accrual is not chargeable notwithstanding the fact that entries in respect of it has been made in his books of account which are maintained on a mercantile basis. 'Hypothetical income' contemplated in these decisions is the income the assessee could have had under the original agreement which was subsequently varied in the course of the current year reducing the quantum before its accrual and once it has accrued, it ceases to be hypothetical income.

30. The concept of 'real income' is based on the above dictum.

31. In the case on hand, the assessee had not given up or forgone the interest but, apprehending that it may have to write off the said interest as irrecoverable at a future date, it has credited the same in a 'suspense account' while debiting the party's account. IE it ultimately writes off such interest, it is not as if the assessee is not entitled to get relief in this regard ; the assessee can and is also entitled to claim the said interest which is written off as bad debt, as a deduction under Section 36(1)(vii) of the Act. In such cases where the assessee is maintaining its accounts on mercantile basis, thereby treating the said income as accrued, the same cannot be treated as income and assessed in another year. We are fortified in this view by the decision of the Supreme Court in Laxmipat Singhania v. CIT : [1969]72ITR291(SC) . The Supreme Court has stated thus (p. 294):

'It is a fundamental rule of the law of taxation that, unless otherwise expressly provided, income cannot be taxed twice. Again, it is not open to the Income-tax Officer, if income has accrued to the assessee, and is liable to be included in the total income of a particular year, to ignore the accrual and, thereafter to tax it as income of another year on the basis of receipt.'

32. We do not wish to burden this judgment by citing all the decisions mentioned at the bar. However, we would refer to the following decisions where the respective High Courts apparently have applied the concept of real income to areas other than those mentioned in the decisions of the the Supreme Court ; CIT v. Motor Credit Co. P. Ltd. : [1981]127ITR572(Mad) , CIT v. Devi Films P. Ltd. [1983] 143 ITR 386 and CIT v. Raigarh Jute Mills Ltd. : [1981]132ITR702(Cal) . As stated in our judgment in I.T.R. Nos. 279 and 280 of 1979, on the facts of those cases, the decisions can be sustained. But whatever that be, the concept of 'real income' enunciated by the Supreme Court, discernible from the decisions cited above, does not warrant an extension of the said concept to cases where income has already accrued.

33. In the view we have taken we have no hesitation to hold that the 'interest' in dispute is liable to be included in the taxable income of the assessed.

34. Before we part with this discussion, we wish to add the following: This is a new point raised before this court. The assessee has not raised this point before the Tribunal and, therefore, the assessee is not entitled in law to raise the said question before this court for the first time, especially when investigation into facts is necessary. It is by now well-established that a new point or plea which 'depends for its validity upon questions of fact which have not been investigated' cannot be raised for the first time before this court in the exercise of its advisory jurisdiction. It has been so held by the Privy Council in Malik Damsaz Khan v. CIT [1947] 15 ITR 445. The Supreme Court in Dhandhania Kedia & Co. v. CIT : [1959]35ITR400(SC) , New Jehangir Vakil Mills Ltd. v. CIT : [1959]37ITR11(SC) , and CIT v. Paluram Dhanama : [1966]60ITR250(SC) has expressed the same view and hence this point which turns on disputed questions of fact cannot be allowed to be raised at this stage.

35. We shall now deal with the letter of the C.B.D.T., annexure B.A taxpayer has a right to enforce beneficial circulars issued by the C.B.D.T. even in courts. It is also well established that subsequent withdrawal of such a circular will not take away the right of a taxpayer to enjoy the benefit conferred on him by the circular during the validity of the circular. Decisions in this respect are many. It is enough if we refer to two decisions of the Supreme Court in Navnit Lal C. Javeri v. K.K. Sen, AAC of LT. : [1965]56ITR198(SC) and Ellerman Lines Ltd. v. CIT : [1971]82ITR913(SC) and a Full Bench decision of this court in CIT v. B.M. Edward, India Sea Foods : [1979]119ITR334(Ker) . It, therefore, follows that if annexure B has all the trappings of a beneficial circular intended to benefit persons like the assessee here, undoubtedly the assessee is entitled to the benefit.

36. The learned counsel for the Revenue, however, submitted that annexure B cannot be treated as a circular leave alone a beneficial circular, because the same appears to be only a letter addressed to the Haryana Government by the C.B.D.T. mentioning therein, perhaps the existence of some circular, the details of which however, are not available therefrom. He further submitted that to say that a particular document or letter is a circular issued, it is necessary that the party who presses that into service shall establish that copies of the said letter/document has been sent to the Income-tax Commissioners in the various States. In this connection, he called our attention to the wording of Section 119 under which the Board is issuing circulars. Relevant part of Section 119 reads :

'(1) The Board may, from time to time, issue such orders, instructions and directions to other income-tax authorities as it may deem fit for the proper administration of this Act, and such authorities and all other persons employed in the execution of this Act shall observe and follow such orders, instructions and directions of the Board :......'

37. The learned counsel laid emphasis on this part of the section, viz., the Board may, from time to time, issue such orders, instructions and directions to other income-tax authorities and submitted that unless copies of the circulars are addressed to the other authorities mentioned in Section 116, the letter/document which is said to be a circular cannot be treated as such. We are of the view that he is well-founded in this submission. Annexure B, therefore, cannot be treated as a circular.

38. The counsel for the assessee, however, brought to our notice certain documents (not produced before the Tribunal) said to be circulars issued by the C.B.D.T. and according to him, the said circulars are applicable to the facts of the case. A reading of these documents, assuming they are circulars, would suggest that an investigation into various facts is necessary before deciding the question whether the assessee is entitled to the benefit thereof. Such a plea was not raised before the Tribunal and, therefore, the said authority had no occasion to go into the facts and decide whether the assessee was entitled to the benefit of these circulars. Since it is not a question arising out of the order of the Tribunal, the assessee is not entitled to raise this point in this court for the first time.

39. In the view we have taken, the questions referred to this court are answered in favour of the Department and against the assessee.

40. A copy of this judgment under the seal of the High Court and the signature of the Registrar shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.


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