Suhas Chandra Sen, J.
1. The relevant facts of this case are asfollows :
The assessment years involved are 1960-61 and 1961-62. The asses-see is a foreign company incorporated in the United Kingdom. The Indian Company, ICI India Ltd., is a wholly owned subsidiary company of the assessee. The assessee entered into an agreement by correspondence for the advance of loans to its Indian subsidiary to enable the latter company to purchase shares of another Indian company, ACCI, with the ultimate object of getting the shares transferred subsequently to itself at the issue price. The assessee advanced loans of Rs. 1,75,30,720 to its Indian subsidiary by three instalments on 31st May, 1957, 31st July, 1957, and 30th November, 1957. The loan was to carry interest on certain terms. The Indian subsidiary debited to its accounts and credited the account of the assessee the following interests :
Rs.A1-10-1959 to 31-12-19592,42,606.69B1-1-1960 to 30-10-19607,20,571.84C1-10-1960 to 31-12-19602,41,943.84
2. The assessee took credit of these interests in its accounts. The previous years relevant to the assessment years under reference respectively ended on 31st December, 1959, and 31st December, 1960. Item 'A' of the above interest fell within the assessment year 1960-61, and remaining two items within the assessment year 1961-62. These two latter items aggregated to Rs. 9,62,515. The assessee exercised its option in February, 1961, for the transfer of the shares by its Indian subsidiary. The shares were ultimately transferred to the assessee in March, 1961. The company, ACCI, declared dividend for the period for which the interest had been credited by the assessee in its accounts after the assessee had become a registered shareholder of those shares and consequently the assessee received the entire dividend from these shares. Considering that, accordingto the terms on which the loan had been advanced, no interest became due from its Indian subsidiary, the assessee reversed the entries with respect to the above interest and refunded the sum of Rs. 12,05,122 being the aggregate of the amounts of Rs. 2,42,607 and Rs. 9,62,513. The assessee submitted the returns showing incomes including the interest amounts of Rs. 2,42,606 and Rs. 9,62,515 respectively in the assessment years 1960-61 and 1961-62. Subsequently, it submitted the revised returns excluding the above interest amounts on the ground that these interest amounts did not accrue and did not constitute the income of the assessee. It was submitted that the interest was computed provisionally and according to the terms for the advance of the loan no interest became due from its Indian subsidiary as the subsidiary did not receive any dividend for the period for which the interest was credited and that the entries had been reversed in the assessment year 1962-63. The ITO found that the interest was credited to the assessee's account and the tax also was deducted and paid and the payment of interest had been made by credit notes passed by the assessee-company on 1st April, 1961. He was of the opinion that the interest could not be excluded from the income of the assessee. He rejected the assessee's contention that no interest accrued as the Indian subsidiary had not received any dividend for the period for which the interest had been credited by the assessee. The ITO, therefore, included the amount of interest of Rs. 2,42,607 and Rs. 9,62,515 in the years under reference.
3. The assessee came up in appeals before the AAC who heard both the appeals together and disposed them of by a common order. The AAC referred to certain parts from the letter of the Indian subsidiary of 7th March, 1957, and to resolution of the board of the Indian subsidiary of 27th March, 1957, as forming terms of the advance of the loans and took the view that the arrangement between the assessee and the Indian subsidiary was that the assessee was to advance the amount in shares of the ACCI and the assessee retained the right to acquire the shares at the purchase price from the Indian subsidiary and that the arrangement envisaged a payment of interest by the Indian subsidiary to the assessee at the rate of 1 1/2% above the bank rate, subject to the condition that the interest rate at no time should exceed the rate of dividend paid by the company on its ordinary shares. The AAC was of the view that the entries in the accounts of the assessee were made at the time when the assessee had not decided to get the shares transferred to it and placing reliance on the decision in the case of CIT v. Shoorji Vallabhdas & Co. : 46ITR144(SC) , he was of the view that making of the entries in the accounts did not create a right to receive interest from the Indiansubsidiary. He deleted the addition made by the ITO in both the years under reference.
4. Aggrieved by the order of the AAC, the Department went up in appeal before the Tribunal. It was urged by the learned representative of the Department that the matter of interpretation of the terms of the advancing of the loan by the assessee to the Indian subsidiary came up for consideration before the Tribunal in the case of the Indian subsidiary for the assessment year 1962-63 in I.T.A. Nos. 20229 and 20252 of 1967-68 and in that case the Indian subsidiary was allowed a deduction of interest of Rs. 9,63,179 in the assessment year 1961-62, and that it was treated as profit in the assessment year 1962-63. It was urged that in those appeals the Tribunal did not accept the contention that the interest could accrue only in case the Indian subsidiary received the dividend. The Tribunal accepted the assessee's contention that in the appeals of the Indian subsidiary the Tribunal had not accepted its (Indian subsidiary) contention that it was liable to pay interest only if it actually received dividend from the ACCI on the ground that the existence of such an arrangement between the Indian subsidiary and the assessee was not proved on the materials before it. The Tribunal observed that in the appeals of the Indian subsidiary, it did not come to a definite finding that there was no such term in the arrangement. The Tribunal again considered the part of the letter of the Indian subsidiary referred to by the AAC in his order and also considered para. 3 of the letter dated 29th February, 1957, and held that these letters clearly envisaged the actual receipt of dividend by the Indian subsidiary for paying of interest to the assessee. The Tribunal also considered another letter of 15th of November, 1957, from the assessee to its Indian subsidiary as supporting the view taken by it. In the face of these letters, the Tribunal observed that it could not come to any other conclusion and it differed from the view taken by the Tribunal in I.T.A. Nos. 20229 and 20252 of 1967-68. The Tribunal observed that entries taking credit of interest were no doubt made in the assessment years under reference but no interest accrued to the assessee on the terms on which the loans were advanced as the Indian subsidiary did not actually receive any dividend from the ACCI for which the interest was sought to be taxed and that the making of the entries was only about an hypothetical income. Relying upon the decision in the case of CIT v. Shoorji Vallabhdas & Co. : 46ITR144(SC) , the Tribunal held that no interest for the years under reference accrued to the assessee and the AAC was justified in deleting the interest amounts in the years under reference from the assessments of the assessee. The Tribunal accordingly dismissed the departmental appeals.
5. At the instance of the Commissioner of Income-tax, the following questions of law have been referred under Section 256(1) of the I.T. Act, 1961:
'1. Whether, on a proper reading of the letters referred to in its order, the Tribunal was justified in holding that interest was to be charged only if I.C.I, India actually received dividend from the ACCI
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 2,42,607 and Rs. 9,62,515 respectively did not accrue as interest to the assessee for the previous year ending on the 31st December, 1959, and 31st December, 1960, respectively ?'
6. The case of the Revenue before us is that a loan was given by the Imperial Chemical Industries, London, to the Imperial Chemical Industries (India) Private Limited which is the Indian subsidiary of the London company. This loan was to carry interest and the interest accrued at the end of the accounting year. It has been argued that subsequent conduct or transaction of the parties after the end of the accounting year will not prevent any accrual of income. The Imperial Chemical Industries (India) Pvt. Ltd. may have good reasons for giving up the interest after the end of the accounting year. The assessment, however, was being done in this case on the basis of the mercantile system of accounting followed by the assessee-company. Therefore, the interest had to be assessed on that basis. It was further argued that in an earlier case the Tribunal itself had held in an appeal arising out of the assessment of the Indian company that the Indian company was entitled to get a deduction for the payment of this interest on accrual basis. If the Indian company was liable to pay interest and was allowed deduction on that basis, there is no reason why the London company should not be assessed on the same income on accrual basis. It has also been argued that there was a liability to pay interest. Final determination of the rate of interest may take place later on ; but at the end of the accounting year there was a right to receive interest and the assessee-company had to be assessed on that interest on accrual basis.
7. There is no clear-cut written agreement between the parties about this loan transaction. There is a series of correspondence between ICI, London, ICI (India) Pvt. Ltd. and also between various Government departments in connection with this loan. Some of these documents have been examined by the Supreme Court in the case of ICI (India) Pvt. Ltd. v. CIT : 83ITR710(SC) , and also by the Calcutta High Court in ICI (India) Pvt. Ltd. v. GTO : 110ITR88(Cal) . But the principles laid down in those two cases are of no assistance to us in this case. The case beforethe Supreme Court was in connection with capital gains and the case before this court was in connection with the gift-tax assessment. In order to decide whether there was an unconditional liability to pay interest on the part of the Indian company to the London company, we shall have to examine the correspondence that has been brought on record by the parties before the Tribunal. The Tribunal has referred to a letter dated 7th March, 1957, written by the ICI (India) Private Limited to the Assistant Controller, Reserve Bank of India, a letter dated 28th February, 1957, written by the ICI (India) Pvt. Ltd. to the ICI. London, a letter dated 15th November, 1957, written by ICI, London, to ICI (India) Pvt. Ltd, and also a letter dated 29th September, 1958, written by ICI (India) Pvt. Ltd. to the Reserve Bank of India. Some of the facts are very clear from these correspondence and are not in dispute before us. ICI, London, was giving a loan of approximately Rs. 1,80,00,000 to ICI (India) Pvt. Ltd. The loan was for the purpose of financing another company, the Alkali and Chemical Corporation of India Limited. ICI (India) Pvt. Ltd. was to invest this amount in the shares of Alkali and Chemical Corporation of India Limited ; and when called upon to do so, ICI (India) Pvt. Ltd. had to transfer these shares to ICI, London, in settlement of the loan that was taken. It was made quite clear in the correspondence that the loan was to be given only for the purpose of buying the shares in Alkali and Chemical Corporation of India Limited. The first instalment of the loan was to be advanced in March, 1957, and the balance as and when calls were made on the shares sold by Alkali and Chemical Corporation of India Limited. Interest was to be paid at the rate of 1 1/2% above the bank rate but this rate was not to exceed the rate of dividend paid by Alkai and Chemical Corporation of India Limited in any year.
8. The only question before us is whether the interest on the loan was unconditionally payable by ICI (India) Pvt. Ltd. at the end of the accounting year or was it unconditional upon receipt of dividend by the Indian company. On a reading of the documents that have been placed before us we are of the view that there was no unconditional accrual of interest in the facts of this case. This was not a simple loan transaction between the London company and the Indian company. ICI, London, wanted to finance Alkali and Chemical Corporation of India Limited. The money was routed through ICI (India) Private Limited for the purpose of getting certain tax benefits in the United Kingdom. This has been explained in the letter dated 28th February, 1957, in the following words:
'The only reason why the ACCI shares are to be held by ICI (India) is to avoid the loss of the tax exemptions. ACCI will be getting throughembarking upon the polythene project, but, in fact, there will be dividends of about 6% almost immediately and as the reality of the arrangement is that the investment is on behalf of ICI, London, it is right that ICI, London, should, so far as possible, have the income or what corresponds to it.'
9. It is also of significance that interest should run only from the date when the new shares rank for dividend. This has been made clear in the letters dated 20th February, 1957, and 15th November, 1957. Therefore, the clear intention of the parties was that no interest will accrue till the new shares became eligible for the dividend. In the letter dated 15th November, 1957, the London company wrote to the Indian company 'Interest is being charged only after the last day of September, 1957, as the shares rank for dividend from the 1st October, 1957, and you will be retaining this income.'
10. The next important point that has been made in the correspondence between the parties is that the interest that was payable was subject to the condition that the rate of interest should not exceed whatever rate of dividend was received by ICI (India) Pvt. Ltd. on its ACCI shareholding. This was made quite clear in the letter dated 28th February, 1957, and was also stated in the letter to the Reserve Bank of India dated 7th March, 1057. In the application that the Imperial Chemical Industries (India) Pvt. Ltd., made to the Reserve Bank of India seeking formal sanction to borrow Rs. 180 lakhs from the London company, it was categorically stated that:
'In order to provide finance for the above transaction, ICI Ltd., London have undertaken to make a loan of Rs. 180 lakhs payable in two instalments, the first instalment being paid in March, 1957, and the balance as and when calls are made on the shares, ICI Ltd., London, have notified us of their intention to charge interest at the rate of 1 1/2% above the bank rate on this loan until such time as the loan is repaid, with the proviso that this rate shall at no time exceed the rate of dividend paid by the company on its ordinary shares.'
11. It appears from this correspondence that the clear understanding of the parties was that the Indian company was to invest the loan of Rs. 1,80,00,000 given by the London company in the purchase of shares of ACCI which was going to embark upon a polythene project and which was likely to give dividend at about 6% almost immediately. The Indian company was to retain the dividend and to pay an amount to the London company which should not exceed the amount of dividend received by it on its ACCI shareholding.
12. It is quite clear that it was not the intention of the parties to treat this loan as an ordinary loan transaction. The loan was being given for a definite purpose. It could only be invested in the purchase of shares in the ACCI. No interest was to be paid on that loan until and unless the new shares acquired by the Indian company became eligible for dividend. The interest that was to be paid to the London company was not to be in excess of the dividend that was going to be received by the Indian company. Therefore, it cannot be said that the Tribunal erred in holding that the payment of interest on the loan was conditional upon receipt of the dividend by the Indian company on the ACCI shares. It was provided in the agreement that when the shares were transferred to the London company the loan would be written off and there would be no further liability to pay any interest on the part of the Indian company. In the facts of this case shortly after the close of the relevant accounting year, the shares were transferred to the London company. The dividend that was declared was received by the London company. Can it be said that the Indian company was liable to pay interest to the London company and that liability had arisen on or before the last day of the accounting period and there was an unconditional right of the London company to receive the interest on that date
13. The question of payment of interest in this case was linked up with the receipt of dividend from the ACCI shares. The liability to pay interest arose only after the shares became eligible for dividend. The rate of interest was dependent upon the rate of dividend declared. In the resolution passed by the board of directors of the Indian subsidiary on 27th March, 1957, it was also specifically stated that 'at no time shall the rate of interest exceed the rate of dividend paid by ACCI on its ordinary shares and subject to the right of ICI Ltd. at a subsequent date to exchange the said shares at their issue price in satisfaction of the loan.
14. The argument that the interest accrued at the end of the accounting year is misconceived. The interest that was to be paid was conditional upon receipt of dividend. If the ACCI did not declare any dividend in any particular year, then the London company could not get any interest on the loan. It cannot be said that the interest accrued irrespective of declaration of dividend. In the peculiar facts of this case the parties made their intention quite clear in the correspondence that passed between them. The loan was really meant for ACCI Limited. ICI (India) Private Limited was made the agency through which the loan was given. ICI (India) Pvt. Ltd. was entitled to retain the dividend that was paid by ACCI Limited but, in its turn, ICI (India) Pvt. Ltd. had to pay an interestto the London company. The amount of interest was to be a fluctuating figure and depended on the amount of dividend that was received by the Indian company and was not to exceed the amount of dividend under any circumstances.
15. Therefore, in our opinion, the Tribunal was not wrong in this case in holding that there has been no accrual of interest to the assessee for the previous year ending on the 31st December, 1959, and 31st December, 1960, respectively. A large number of cases have been cited in which the principle of accrual of income and mercantile system of accounting has been explained. Reliance has been placed on the decisions of the Supreme Court in the cases of CIT v. K.R.M.T.T. Thiagaraja Chetty & Co. : 24ITR525(SC) , CIT v. A. Gajapathy Naidu : 53ITR114(SC) and also E.D. Sassoon & Company Ltd. v. CIT : 26ITR27(SC) , in which the principles of the mercantile system of accountancy have been explained. The principles applicable to a case of accrual of income are well-settled. But, in our opinion, in this case a perfected debit for payment of interest had not come into existence on the last day of the accounting year. The liability to pay interest was conditional upon the receipt of the dividend by the Indian company and that was made quite clear by the resolution passed by the board of directors of the Indian company at the time of accepting the loan.
16. In this case, the parties had made payment of interest conditional upon receipt of dividend. It was also agreed that the London company was entitled to call upon the Indian company to transfer the shares acquired in ACCI at any point of time. This was an arrangement which had been made at the time when the loan was advanced. It was not an arrangement that was made after the end of the relevant accounting period. On the basis of this arrangement, the assessee-company has received and paid tax on the dividend that was paid on the ACCI shares for this period.
17. Therefore, we are of the view that the Tribunal was right in holding that there had been no accrual of interest to the assessee-company at the end of the relevant accounting period.
18. Before we part with this case, it must be mentioned that Dr. Pal, on behalf of the assessee, has pointed out that there will be no loss of revenue in this case. The Indian company was allowed certain deductions on accrual basis in this very assessment year with which we are concerned. But in the subsequent assessment year this amount was added to the income of the Indian company and this was pointed out to the Tribunal. It has been contended that as a matter of fact the Revenue has not suffered by the decision of the Tribunal in this case in any way.
19. In the assessment of the Indian company, ICI, London, was not a party. We are also not aware what documents were placed before the Tribunal in that case by the Indian company. In any event, we have proceeded in this case on the basis of the facts found by the Tribunal and the documents that have been placed before us.
20. Therefore, in the facts and circumstances of this case, both the questions are answered in the affirmative and in favour of the assessee.
21. The parties will pay and bear their own costs.
Sabyasachi Mukharji, J.
22. I agree.