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PETITIONER: STATE BANK OF TRAVANCORE

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX, KERALA

DATE OF JUDGMENT08/01/1986

BENCH: TULZAPURKAR, V.D. BENCH: TULZAPURKAR, V.D. MUKHARJI, SABYASACHI (J) MISRA RANGNATH

CITATION:  1986 AIR  757            1986 SCR  (1)  25  1986 SCC  (2)  11        1986 SCALE  (1)34  CITATOR INFO :  RF         1991 SC1806  (6,13)

ACT:      Income Tax Act, 1961:      Sections 28,  29 &  145 -  Banking Company  -  Advances considered doubtful  of recovery-interest  on such  ’sticky’ advances not carried in ’Profit and Loss Account’ - Credited to separate  account - ’Interest suspense account’ - Accrual of income  - Whether  arises -  Interest  amount  -  Whether exemption from  tax -  Concept and  notion of  real income - Explained.      Method of accounting - How far relevant for computation of income,  profits and  gains - Mercantile and cash systems of accounting - Difference between.      Devaluation  of  Indian  Rupee  -  Exchange  difference arising therefrom - Whether income assessable to tax.

HEADNOTE:      The assessee,  a subsidiary  bank of  the State Bank of India, used  to maintain  in the accounting years 1964, 1965 and 1966,  its accounts  in mercantile system making entries and calculating income and loss on accrual basis and adopted the calendar year as its previous year. The assessee, in the course of  its banking  business, used to charge interest on advances considered  doubtful of  recovery termed as ’sticky advances’ by  debiting the  concerned parties but instead of carrying the  same to  its ’Profit & Loss Account’, credited the same  to a  separate account  called ’Interest  Suspense Account’ as the principal amounts of these ’sticky advances’ themselves  had   become  not   bad  or  irrecoverable,  but extremely doubtful  of recovery. In its returns the assessee disclosed such  interests separately  and claimed  that  the same were  not taxable  in  its  hands  as  income  for  the concerned years.      The business  of the assessee bank also included buying and selling  of foreign  exchange and  before devaluation of the Indian  Rupee on  August 6, 1966, the assessee bank held foreign 26 exchange by  way  of  cash  balances  available  with  their foreign  correspondents,   forward   contracts,   items   in

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transits, etc.  in U.S.  Dollars and  in Sterling,  which on devaluation of  the Indian  Rupee  when  converted  back  to rupees at  the post  devaluation rates gave rise to a profit of 57.5% in the transaction; the assessee bank-credited this surplus   to    an   account   designated   "Provision   for Contingencies". In  the Assessment Year 1967-68 the assessee bank claimed  that profit  by way  of exchange difference on devaluation should  not be  taxed as  it was of a casual and non-recurring nature.      The claim  of the  assessee bank  on both these aspects was  rejected  by  the  Income-tax  Authorities,  Income-tax Appellate Tribunal  and the High Court. The High Court held: (a) the  assessee was  following the  mercantile  system  of accounting; such  interest, therefore,  had accrued  to  the assessee at  the end  of the  accounting year;  and (b)  the assessee itself  had  treated  such  income  as  accrual  of interest by  charging the  same to  the parties concerned by making debit  entries in their respective accounts. However, if  any   part  of   these  debits   had  later   on  become irrecoverable in  any year, the assessee could have, in that year, treated  the same  as such and claimed deduction under section 36(1)(vii) of the Income Tax Act, 1961.      In the  appeals to this Court on behalf of the assessee bank it  was contended: (1) that the three sums representing interest on  ’sticky’ advances,  i.e.  advances  in  respect where of  there was  high improbability  of recovery of even the principal  amounts, ought  not to have been subjected to tax as  income under  the Act;  that what  are chargeable to income-tax in  respect of  a business  are profits and gains actually resulting  from the  transaction  of  the  previous year, that  is to  say, the  real profits  and gains and not hypothetical profits  or gains  on a  doctrinaire theory  of accrual; that even under the mercantile system of accounting regularly adopted  by an  assessee it  is only the acrual of "real income" in the commercial sense which is chargeable to tax, that  accrual is a matter of substance to be decided on commercial principles having regard to business character of the transaction  and the  realities  of  the  situation  and cannot be determined on any abstract theory of accrual or by adopting a  legalistic approach and that if regard is had to the commercial  principles and realities of the situation it will be clear that in 27 the case of banks, financial institutions and money-lenders, whose bulk  profits mainly  consist of  interest  earned  by them, there  is no accrual of real income so far as interest on sticky  advances and the debit entries made in respect of such interest  in the  respective accounts  of the concerned debtors following the mercantile system of accounting merely reflected hypothetical  income that  does not materialise in the concerned  accounting year  or years  during  which  the advances remain  sticky and  hence it is but proper to carry such interest to "Interest Suspense Account’ as carrying the same to  ’Profit and  Loss Account’  would result in showing inflated profits and might even lead to improper and illegal distribution or  remittance thereof;  (2) that  there  is  a clear distinction  between an  irrevocable loan and a sticky loan; the former is a bad debt in respect whereof the chance of recovery is nil and as such can outright form the subject matter of  deduction under  section 36(i)(vii)  of  the  Act while the  latter is  a loan  to  which  a  high  degree  of improbability of  recovery attaches  in a particular year or years depending upon the financial position of the concerned debtor due  to which  interest thereon  becomes hypothetical income during such year or years and, as such, the same, not

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being real  income, cannot be brought to tax; (3) that right from August  1924 onwards  till the  decision  of  the  High Courts distinction  between  an  irrecoverable  loan  and  a sticky loan  was recognised  by the Central Board of Revenue as also  by the  Reserve Bank  of  India  in  their  diverse Circulars in  the case  of banks, financial institutions and money-lenders regularly  following the  mercantile system of accounting and  that Instructions  had been  issued  not  to treat the  unrealised interest  on sticky loans as income by carrying it  to ’Profit and Loss Account’ so that the figure of  distributable   profits  should  not  get  inflated  and preferably to credit the same to a special account ’Interest Suspense  Account’   and  that   if  the   banks,  financial institutions and  money-lenders, who  kept their accounts on mercantile system,  maintained a  suspense account  in which the unrealised  interest was entered, the same should not be included in the assessee’s taxable income, if the Income Tax Officer was  satisfied that  there was really probability of the loans  being repaid; (4) that the Instructions contained in various  Circulars were  in consonance  with the accepted principle that  what was chargeable under the Income Tax Act was the  real income  of an  assessee but these instructions which held  field for  over 53  years were  changed,  though wrongly, under fresh circulars issued by the Central 28 Board of  Direct Taxes  whereunder interest  on doubtful  or sticky loans  became includible  in the assessable income of the assessee  with effect  from the assessment year 1979-80, and (5) that in the case of banks and financial institutions who regularly  adopted mercantile  system of  accounting the practice of  carrying  interest  on  such  sticky  loans  to ’Interest  Suspense   Account’  or   ’Reserve  for  Doubtful Interest  Account’   in  stead  of  crediting  the  same  to ’Interest  Account’  or  ’Profit  and  Loss  Account’  is  a universally recognised  practice invariably  adopted by them and being  wholly consistent  with the  mercantile system of accounting the  Income Tax  Officer was bound to give effect to it  under section  145 of  the Act  and,  therefore,  the treatment of  the three sums representing interest on sticky loans as the assessee’s income for the concerned years would be unsustainable in law.      On behalf  of the  Revenue it  was contended:  (1) that though it is the real income that is chargeable to tax under the Act  and not  any hypothetical income of an assessee and that  under   section  28  in  respect  of  a  business  the chargeability must  attach to real profits and gains arising from the  transactions  of  the  previous  year,  but  under section 5  read with  section 28  of the  Act the  liability attaches to  profits which  have been either received by the assessee or  which have  accrued to  him during  the year of account and  that income  accrues when  it "falls due", i.e. becomes legally recoverable irrespective of whether actually received or  not and  "accrued income"  is that income which "the assessee  has a  legal right  to receive" and since the assessee has  been maintaining  its accounts  on  mercantile basis the  three  sums  being  interest  on  loans,  whether doubtful or  sticky, fell  due and  became  payable  to  the assessee at  the end  of each  of the three accounting years and  constituted   its  accrued   income   and,   therefore, justifiably brought  to  tax  in  the  concerned  assessment years; (2)  that though,  while imposing  the tax  liability under the Act, the Courts have recognised the theory of real income by  having regard  to the  business character  of the transactions  and  realities  of  the  situation  but  these aspects have  been taken  into account  for the  purpose  of

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determining whether the income could be said to have legally accrued or  not and once it is found to have legally accrued it is  brought to tax and that the theory of real income has been invoked  and confined  only to  two types  of cases (a) where there  has been  a surrender  of income  which may  in theory have  accrued, and (b) where there has been diversion of income at source either 29 under a  statute or  by over riding title but in none of the cases has  the aspect of high improbability of recovery been regarded as  sufficient to  prevent accrual;  therefore  the theory of  real income  should not  be  extended  so  as  to exclude from chargeability such income which has accrued but merely suffers  from high improbability of recovery, because such extention  would be neither permissible nor advisable - not permissible  because it goes against the very concept of accrued income  and not  advisable because  if done  it will apply to  all cases  and not  merely to  cases  of  interest accruing to banks and financial institutions. Such extension will  moreover  entrench  upon  section  36(1)  (vii)  which provides for  deductions of  a debt  or part  thereof on its becoming bad  on fulfilment  of certain conditions specified in sub-section  (2) thereof; for these reasons the extension of the  theory of real income so as to take within its ambit the consideration  of high  improbability of recovery is not warranted. As regards the Circulars of C.B.R. and R.B.I., it was submitted  that these merely granted a concession to and conferred no  right in favour of the assessee which could be and has  been withdrawn later by issuing fresh Circulars but since the  benefit  or  the  concession  in  favour  of  the assessee  could   not  be   withdrawn  retrospectively,  the withdrawal of  concession has  been  effected  prospectively from the assessment year 1979-80.      Dismissing the appeals, ^      HELD: Per  Tulzapurkar, Mukharji  and Ranganath  Misra, JJ. (concurring).      The principle that if the stock-in-trade remains unused or unsold  the mere  book appreciation  in the value thereof cannot be  brought to  tax is well accepted. However, in the instant case,  the assessee  bank by  carrying  the  surplus resulting from  the devaluation  of the  Indian rupee  to an account designated  ’Provision for  Contingencies’ could  be said to  have clearly  treated such  surplus as its business income. Further, the Appellate Assistant Commissioner in his appellate order  recorded a  categorical  finding  that  the stock in  trade in  terms of  foreign currency  was sold and used by  the assessee  in its normal business. Having regard to this factual position the exchange difference arising out of devaluation  of the  Indian rupee  was rightly treated as income of  the assessee  in the assessment year 1967-68. [65 C; 66 G-H; 67 A & D]      C.I.T. v. Mughal Line Ltd., 46 I.T.R. 590 referred to. 30      Per Mukharji,  J. (1) It is the income which has really accrued or  arisen to  the assessee  that is  taxable. Under Income-tax law,  receipt of income, either actual or deemed, is not  a condition  precedent to the taxability. These were assessable if  these had arisen or accrued or deemed to have accrued or  arisen under  the Act.  This principle  would be attracted even  in cases  where  an  assessee  followed  the mercantile system  of accounting.  However, in examining any transaction or  situation, the  court would have more regard to  the   reality  of   the  situation  rather  than  purely theoretical or doctrinaire aspect. [92 A; 86 F-G]

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    2. The  profits and  gains chargeable  to tax under the Act are  those  which  have  been  either  received  by  the assessee or  have accrued  to the assessee during the period between the  first and  the last  day of the year of account and are  receivable. Income  received or  income accrued are both chargeable to tax under section 28 of the Act. [74 C]      3. By  and large,  two systems  of account  keeping are followed one is the cash and the other, mercantile. The cash system  postulate   actual  receipt   of  money;   and   for exigibility of  income  tax,  such  receipt  from  business, profession or  vocation or  from other  sources  has  to  be actual in  the relevant  year  of  account.  The  mercantile system is  one where accounts are maintained on the basis of entitlement to  credit and/or debit. A sum of money, as soon as  it  becomes  payable,  is  taken  into  account  without reference to  actual receipt  and a debit becomes admissible when liability  to pay  is created  even though  the sum  of money is yet to be paid. [72 B-C]      Dhakeshwar  Prasad  Narain  Singh  v.  Commissioner  of Income Tax,  Bihar & Orissa, 4 I.T.R. 71 at 74, Commissioner of Income  Tax, Bombay v. Sarangpur Cotton Manufacturing Co. Ltd., 6  I.T.R. 36,  Commissioner of  Income-tax v. Shrimati Singari Bai,  13 I.T.R.  224 and Commissioner of Income-tax, Madras v.  A. Krishnaswami  Mudaliar and Ors., 53 I.T.R. 122 referred to.      4.  The   income  of  the  assessee  will  have  to  be determined  according  to  the  provisions  of  the  Act  in consonance with the method of accountancy regularly employed by the assessee. The method of accounting regularly employed by the  assessee helps  computation of  income, profits  and gains under section 28 of the Act and the taxability of that income under  the Act,  will then have to be determined. The circulars being executive in 31 character cannot  alter the  provisions of the Act and being in the  nature of  concessions could always be prospectively withdrawn. [75 A-B]      Commissioner  of   Income-tax,  Madras   v.  K.R.M.T.T. Thiagaraja Chetty  & Co.,  24 I.T.R.  525, Dhakeshwar Prasad Narain Singh  v. Commissioner of Income Tax, Bihar & Orissa, 4 I.T.R  71 at  74, Commissioner  of Income-tax  v. Shrimati Singari Bai,  13 I.T.R.  224 &  Commissioner of  Income-tax, Madras v.  A. Krishnaswami  Mudaliar and Ors., 53 I.T.R. 122 referred to.      5. Mere improbability of recovery, where the conduct of the assessee is unequivocal cannot be treated as evidence of the fact  that income  has not  resulted or  accrued to  the assessee.  After  debiting  the  debtor’s  account  and  not reversing that  entry -  but taking  the interest  merely in suspense account  cannot be  such evidence  to show  that no real income  has accrued  to the assessee or treated as such by the  assessee. If  the actuality  of a  situation or  the reality of  a particular  situation makes  an income  not to accrue, then  very different considerations would apply. But where interest  has accrued and the assessee has debited the account of  the debtor, the difficulty of the recovery would not make the accrual non-accural of interest. [92 C-D; 89 B- C]      Catbolic Bank of India (In liquidation) v. Commissioner of Income-tax, Kerala, Ernakulam, 1964 K.L.T. 653 = 1965 (1) I.T. Journal  355, Commissioner  of Income-tax,  Bombay I v. Confinance Ltd.,  89 I.T.R.  292 and  James Finlay  & Co. v. Commissioner of Income Tax, 137 I.T.R. 698 approved.      6. An  acceptable formula  of co-relating the notion of real income in conjunction with the method of accounting for

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the purpose  of computation  of income  for the  purpose  of taxation is  difficult to  evolve.  Besides,  any  straight- jacket  formual   is  bound   to  create   problems  in  its application to  every situation.  It must  depend  upon  the facts and  circumstances of each case. It would be difficult and improper  to extent  the concept  of real  income to all cases depending  upon the  ipse dixit  of the assessee which would then  become a  value judgment  only. What  has really accrued to  the assessee  has to  be found  out and what has accrued must  be considered  from the  point of view of real income  taking   the   probability   or   improbability   of realisation in a realistic manner and dovetailing 32 of these  factors together, but once the accrual takes place on the  conduct of  the parties  subsequent to  the year  of closing, an  income which  has accrued  cannot be  made  "no income". The  conduct of  the parties in treating the income in a  particular manner  is material  evidence of  the  fact whether income has accrued or not. [91 B-C; E-F; 92 C]      7. The  concept of  real income  is a well accepted one and  must   be  applied   in  appropriate   cases  but  with circumspection and  must not  be called in aid to defeat the fundamental principles of income-tax as developed. [92 F]      8. The  concept of  real income would apply where there has been  a surrender of the income which in theory may have accrued but  in the  reality of  the situation no income has resulted because  the income  did not really accrue. Where a debt has  become bad  and deduction  in compliance  with the provisions of  the Act  should be  claimed and  allowed.  If there is any diversion of income at source under any statute or by  overriding title  then there  is  no  income  to  the assessee. [92 A-C]      9. Once the accrual takes place and income accrues, the same cannot  be defeated  by any  theory of  real income. In some limited  fields where something which is the reality of the situation  prevents the  accrual of the income, then the notion of  the real  income i.e. making the income accrue in the real sense of the term can be brought into play, but the notion of  real income  cannot be  brought into  play  where income has accrued according to the accounts of assessee and there is  no indication  by the assessee to treat the amount as  not   having  accrued.   Suspended  animation  following inclusion of  the amount in suspense account does not negate accrual and  after the  event of  accrual,  corroborated  by appropriate entry  in the  books of account on the mere ipse dixit of  the assessee,  no reversal of the situation can be brought about. [88 D; 81 B-D]      Morvi Industries  Ltd. v.  Commissioner  of  Income-Tax (Central), Calcutta,  82 I.T.R. 835 and Calcutta Co. Ltd. v. Commissioner of  Income-Tax, West Bengal, 37 I.T.R. 1 relied upon.      Commissioner of  Income-Tax, Bombay  City, I v. Messrs. Shoorji Vallabhdas  and Co.,  46 I.T.R. 144, Commissioner of Income-tax, Bombay  North Kutch and Sturashtra, Ahmedabad v. Chamanlal Mangaldas & Co., 29 I.T.R. 987, Morvi Industries 33 Ltd. v.  Commissioner of  Income-Tax (Central)  Calcutta, 82 I.T.R. 835,  H.M. Kashiparekh  & Co.  Ltd.’s case, 39 I.T.R. 706, Commissioner  of Income-Tax,  West Bengal,  II v. Birla Gwalior (P) Ltd., 89 I.T.R. 266, Commissioner of Income-tax, Tamil Nadu-V  v. Motor  Credit Co. (P) Ltd., 127 I.T.R. 572, Commissioner of Income-Tax, Madras Central v. Devi Films (P) Ltd.,  143   I.T.R.  386  and  Commissioner  of  Income-Tax, Amritsar-II v.  Ferozepur Finance  (P) Ltd.,  124 I.T.R. 619 distinguished.

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    10. The  concept of real income cannot be so used as to making accrued  income, non-income  simply because after the event of  accrual, the  assessee neither decides to treat it as bad  debt nor claims deduction under section 36(2) of the Act, but  still enters  the same  with a  diminished hope of recovery in  the suspense  account. Extension of the concept of real  income to this field to negate after the amount had become payable is contrary to the postulates of the Act. [82 B-C]      Per Ranganath Misra, J. (concurring)      Section 36(2)  of  the  Act  covers  the  entire  field regarding deduction  for bad  debt. Though  the  concept  of ’real  income’   is  well   recognised  one,  it  cannot  be introduced as  an outlet  of income  from taxman’s  net  for assessment on the plea that though shown in the account book as having  accrued, the  same became  a bad debt and was not earned at  all. The  citizen is  entitled to  the benefit of every ambiguity  in a  taxing statute  but where  the law is clear considerations  of hardship,  injustice or  anomaly do not  afford   justification  for   extempting  income   from taxation. [93 C-D]      Mapp v.  Oram,  1969  (Vol.III)  All  E.R.  219  (H.L.) referred to.      Per Tulzapurkar, J. - (dissenting)      1. Under the Income Tax Act in order that income should accrue it  should not  merely fall  due  or  become  legally recoverable but  should also  be factually  and  practically realisable during  the accounting  year or  years. In  other words mere  non-receipt of  income, when  it  is  reasonably realisable, will not affect accrual but factual or practical unrealisability thereof  may prevent  its accrual  depending upon  the   facts  and   circumstances  attending  upon  the transaction. [59 F-G] 34      2. This  theory of  real income  could be and should be extended to  interest on  sticky loans and that on principle such interest  being hypothetical  cannot be brought to tax. [64 G-H]      3. That the stickiness of advances or loans objectively established to the satisfaction of the taxing authorities by producing proper  material, is  sufficient  to  prevent  the accrual of  interest thereon  as real  income and would have the effect  of rendering  such income  hypothetical and  the same cannot be brought to tax. [59 E-F]      4. Under  section 145  the assessee’s regular method of accounting determines  the mode  of  computing  the  taxable income but it does not determine or even affect the range of taxable income or the ambit of taxation. In other words, any hypothetical income which may have theoretically accrued but has not  truly resulted  or materialised  in  the  concerned accounting year  cannot be  brought to change simply because the assessee  has been  regularly employing  the  mercantile system of  accounting and  makes entries  in  his  books  in regard to such hypothetical income. [47 F-G]      5. The  method of  accounting regularly  employed by an assessee is  relevant only for the purpose of computation of income, profits and gains under s. 28 of the Act and that it cannot enlarge or restrict the content of the taxable income under the  Act and  that under s. 145 the assessee’s regular method  of  accounting  determines  the  mode  of  computing taxable income  but it does not determine or even effect the range of taxable income or ambit of taxation. [49 C-D]      6. In the case of interest on sticky loans the practice of debiting  the accounts of the concerned debtors with such interest  and   carrying  the  same  to  ’Interest  Suspense

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Account’ instead  of to  "Interest Account’  or ’Profit  and Loss Account’  is a well recognised and accepted practice of commercial accountancy,  that it  is wholly  consistent with mercantile method  of accounting  and that  it prevents  the wrong crediting  and improper  and illegal  distribution  or remittance of inflated and unreal profits. [52 D-E]      7. Under  s. 5  taxability is attracted not merely when income is  acutally received  but also when it has ’accrued’ and income  accrues when it ’falls due’, that is to say when it becomes legally recoverable irrespective of whether it is actually received or not and ’accrued income’ is that income which ’the  assessee has a legal right to receive.’ [52 F-G] 35      8. Where  income  or  part  thereof  has  theoretically accrued but  has been, either unilaterally or as a result of bilateral arrangement, voluntary relinquished or surrendered by the  assessee before  its  accrual  the  same  cannot  be regarded as  real income  of  the  assessee  and  cannot  be brought to  tax. Such conclusion is reached having regard to the business character of the transactions and the realities of the situation notwithstanding that some entries have been made in  the assessee’s  books maintained  in the mercantile system. [55 C-D]      9. Even  under  the  mercantile  system  of  accounting whenever adopted it is only the accrual of real income which is chargeable  to tax, that accrual is a matter of substance and that  is to  be decided  on commercial principles having regard to the business character of the transactions and the realities and  specialities of  the situation  and cannot be determined by  adopting purely theoretical or doctrinaire or legalistic approach. [58 H; 59 A]      Catholic Bank of India (In Liquidation) v. Commissioner of Income-tax, Kerala, 1964 K.L.T. 653 = 1965 (1) Income-tax Journal 355,  C.I.T. v.  Confinance Ltd.,  89 I.T.R.  292  & James Finlay & Co. v. C.I.T., 137 I.T.R. 698 overruled.      C.I.T. v.  Motor Credit  Co. (P)  Ltd., 127 I.T.R. 572, C.I.T. v.  Devi Films  (P) Ltd.,  143 I.T.R.  386, C.I.T. v. Ferozepur Finance (P) Ltd., 124 I.T.R. 619, Dhakeswar Prasad Narain singh  v. Commissioner  of Income Tax, 4 I.T.R. 71 at 74 & H.M. Kashiparekh Co.!s case, 39 I.T.R. 706 approved.      C.I.T. v. Sarangpur Cotton Mfg. Co., 6 I.T.R. 36 at 40, C.I.T. v.  Singari Bai,  13 I.T.R. 224 at 227, C.I.T. Madras v. A. Krishnaswami Mudaliar & Ors., 53 I.T.R. 122, C.I.T. v. Shoorji Vallabhdas  & Co.  46 I.T.R.  144, C.I.T.  v.  Birla Gwalior (P)  Ltd., 89 I.T.R. 266 and Kohler!s Dictionary for Accountants 3rd Edn. relied on.      C.I.T. v.  Thiagaraja Chetty,  24 I.T.R.  525  at  531, Morvi Industries  Ltd. v.  C.I.T. Calcutta, 82 I.T.R. 835 at 840, C.I.T.  v. Harivallabhadas  Kalidas & Co., 39 I.T.R. 1, C.I.T. Madhya  Pradesh v. Kalooram Govindram, 57 I.T.R. 630, Poona Electric  Supply Co.  Ltd. v. C.I.T. Bombay, 57 I.T.R. 521, C.I.T.  v. Sir  S.M. Cnitnavis, 6 I.T. Cases 453 Shukla and Grewal referred to. 36

JUDGMENT:      CIVIL APPELLATE  JURISDICTION : Civil Appeal Nos. 1860- 62 (NT) of 1973.      From the  Judgment and  Order dated  22.3.1973  of  the Kerala High Court in I.T.R. Nos. 27 to 29 of 1971.      N.A. Palkhiwala,  S.E.  Dastur,  M/s.  J.B.Dadachandji, Ravinder Narain,  Mrs. A.K.  Verma and  Jeol Peres  for  the Appellant.

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    V.S. Desai,  B.B. Ahuja  and Miss A. Subhashini for the Respondent.      N.A. Palkhiwala,  S.E. Dastur,  M/s.  J.B.  Dadachanji, Mrs. A.K.  Verma and  D.N. Mishra, for the Intervenors (M/s. Grindlays Bank, Calcutta and State Bank of Travancore).      Dr. P. Pal and D.N. Gupta for the Intervenor (Chartered Bank).      F.N. Kaka,  Mr. S.E.  Dastur, C.S.  Shroff, S.S. Shroff and S.A.  Shroff for  the Intervenor  (Industiral  Credit  & Invest-ment Corpn.,  & American  Express International  Bank and City Bank Banking Corpn.)      S.E. Dastur,  S.N. Talwar  and  H.S.  Parihar  for  the Intervenor (Mercantile Bank Ltd.).      K. Ram Kumar, K. Ram Mohan and Mrs. J. Ramachandran for the Intervenor (Indian Overseas Bank, Madras).      The following Judgments were delivered      TULZAPURKAR, J.  These appeals  by certificate from the High Court  raise the following two interesting questions of law for our determination:           (1) Whether  on the facts and in the circumstances           of the case the addition of the sum of Rs. 67,170,           Rs. 47,777  and Rs.  57,889, representing interest           on !sticky! advances, as income for the assessment           years 1965-66,  1966-67 and  1967-68  respectively           was justified in law?           (2) Whether  on the facts and in the circumstances           of  the   case  the  exchange  difference  of  Rs.           1,66,128 37           arising on  devaluation of  the  Indian  rupee  on           6.6.1966 was  rightly treated  as income  for  the           assessment year 1967-68?      The facts  giving rise  to the  first question lie in a narrow compass  and are  these. The assessee is a subsidiary of the  State  Bank  of  India;  it  maintains  accounts  on mercantile system making entries on accrual basis; it adopts the calendar  year as  its previous  year and  the  calendar years 1964,  1965 and  1966 are  respectively  the  relevant previous years for the assessment years 1965-66, 1966-67 and 1967-68 to  which the question relates. In the course of its banking business  the assessee  charged interest  on advance considered doubtful  of  recovery  otherwise  called  sticky advances by  debiting the  concened parties  but instead  of carrying it  to its  !Profit and  Loss Account! credited the same  to   a  separate  account  styled  !Interest  Suspense Account! as  the principal amounts of these stickly advances themselves  had   become,  not   bad  or  irrevocerable  but extremely doubtful  of recovery. However, in its returns the assessee disclosed such interest separately and claimed that the same  was not  taxable in  its hands  as income  for the concerned years.  The amounts  so charged  to the  concerned parties but credited to the !Interest Suspense Account! were Rs. 67,170  Rs. 47,777  and Rs.  57,889 for  the  assessment years 1965-66, 1966-67 and 1967-68 respectively.      Before  the  taxing  authorities  as  also  before  the Tribunal  and   the  High  Court  the  assessee  raised  the contention that having regard to the deteriorating financial position of  the concerned  parties  and  history  of  their accounts, the  recovery of  even the  principal amounts  had become highly  improbable and  extremely doubtful  rendering the advances  !sticky! and  as such  the  interest  thereon, though debited  to them,  was, following  a well  recognised principle of  commercial  accountancy,  taken  to  !Interest Suspense Account! so as to avoid showing inflated profits by including hypothetical  income and  since such  interest was

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not its  real income, the same was not taxable in its hands. The contention was rejected at all the levels principally on two  grounds   -  (a)  since  admittedly  the  assessee  was following the  mercantile system of accounting such interest had accrued to it at the end of each accounting year and (b) the assessee  had itself  shown the accrual of such interest by charging  the same  to the  concerned parties  by  making debit entries in their accounts. It was observed that if any part of the debts later became irrecoverable in any 38 year the  assessee could  in that  year treat it as such and claim deduction  under s. 36 (1) (vii) of the Income Tax Act 1961. In  holding that  these three  sums  were  taxable  as income in  the hands of the assessee for the concerned years the High Court followed its earlier decision in the, case of Catholic Bank  of India  (In Liquidation) v. Commissioner of Income-tax, Kerala,  [1964] K.L.T. 653 = [1965] 1 Income-tax Journal 355  where  despite  the  directive  issued  by  the Reserve Bank  of India  to the  assessee-bank not  to  carry interest  on  such  sticky  advances  to  !Profit  and  Loss Account! and  despite the fact that the assessee-bank had in pursuance thereof  ommitted such  interest from  its !Profit and Loss  Account! the  Court had  taken the  view that such interest was taxable as income in the hands of the assessee- bank because of the mercantile system of accounting that had been regularly  employed by  it, which  had not been changed even after  receiving the  directive from  the Reserve Bank. The High Court was of the view that the facts of the instant case were  indistinguishable from  those  obtaining  in  the Catholic Bank’s  case except that there was a directive from the Reserve  Bank of  India to  the Catholic  Bank which was absent in the case before it but in its opinion the presence or absence of such directive from the Reserve Bank could not determine the  question whehter  there was accrual of income or not and that in the case before it also there was accrual of income  to the assessee considering the mercantile method of accounting that had been regularly adopted by it. In this view of  the matter  the High  Court answered  the  question against  the   assessee  and   in  facour  of  the  revenue. Incidentally it  may be  stated in  the case  of  this  very assessee the High Court, following the decision herein, took a similar  view and  answered a similar question against the assessee for  the subsequent  year  1968-69  which  decision rendered in  1975 is  reported in  110 ITR 336. The assessee has challenged this view before us in these appeals.      Mr. Palkhivala  the learned  counsel for  the  assessee raised a two-fold contention in support of his plea that the three sums  representing interest on !sticky! advances, i.e. advances in  respect whereof there was high improbability of recovery of  even the  principal amounts  ought not  to have been subjected  to tax as income under the Act. In the first place he contended that what are chargeable to income tax in respect  of  a  business  are  profits  and  gains  actually resulting from  the transactions  of the previous year, that is to  say, the  real profits and gains and not hypothetical profits or gains 39 on a  doctrinaire theory  of accrual,  that even  under  the mercantile system  of accounting  regularly  adopted  by  an assessee it  is only  the accrual  of  real  income  in  the commercial sense which is chargeable to tax, that accrual is a matter of substance to be decided on commercial principles having regard  to business character of the transactions and the realities  of the  situation and cannot be determined on any abstract  theory of  accrual or by adopting a legalistic

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approach and  that if regard is had to commercial principles and realities  of the situation it will be clear that in the case of  banks, financial  institutions and  money  lenders, whose bulk  profits mainly  consist of  interest  earned  by them, there  is no accrual of real income so far as interest on sticky  advances is concerned, and the debit entries made in respect  of such  interest in  the respective accounts of the concerned  debtors following  the mercantile  system  of accounting merely  reflect hypothetical income that does not materialise in the concerned accounting year or years during which the  advances remain sticky and hence it is but proper to carry  such interest  to !Interest  Suspense Account!  as carrying the  same to !Profit and Loss Account! would result in showing  inflated profits and might even lead to improper and illegal  distribution or  remittance  thereof.  In  this behalf counsel cited several decisions of this Court as also of the  High Courts  where the  principle of real income has been  recognised  and  invoked  while  considering  the  tax liability under  the Act  and in  particular strong reliance was placed  on two  decisions of  the Madras  High Court  in C.I.T. v.  Motor Credit  Co.(P) Ltd.,  127  I.T.R.  572  and C.I.T. v.  Devi Films  (P)  Ltd.  143  I.T.R.  386  and  one decision of  the Punjab  and Haryana High Court in C.I.T. v. Ferozepur Finance  (P) Ltd.  124 I.T.R. 619 where a view has been taken  that it  will be  totally unrealistic  to  treat interest on sticky loans as income and the same was excluded from computation  of the  assessee!s  income.  According  to Counsel  there   is   a   clear   distinction   between   an irrecoverable loan  and a  sticky loan;  the former is a bad debt in respect whereof the chance of recovery is nil and as such can  out right  form the  subject matter  of  deduction under s.  36 (1) (vii) of the Act while the latter is a loan to which a high degree of improbability of recovery attaches in a  particular year  or years depending upon the financial position of  the concerned  debtor  due  to  which  interest thereon becomes hypothetical income duringsuch year or years and, as  such, the  same, not  being real  income, cannot be brought to  tax. Counsel  pointed out that right from August 1924 onwards till the 40 impugned decision herein as also the further decision in 110 ITR 336  were rendered  by the Kerala High Court in 1973 and 1975  respectively  the  aforesaid  distinction  between  an irrecoverable loan  and a stickly loan was recognised by the Central Board  of Revenue  as also  by the  Reserve Bank  of India in  their diverse  Circulars in  the  case  of  banks, financial institutions and money lenders regularly following the mercantile  system of  accounting and he further pointed out that  Instructions had  been issued  not  to  treat  the unrealised  interest  on  such  sticky  loan  as  income  by carrying it  to !Profit and Loss Account! so that the figure of  distributable   profits  should  not  get  inflated  and preferably to  credit the  same to a special account such as Interest Suspense Account! and that if the banks, financial institutions and  money lenders,  who kept their accounts on mercantile system,  maintained such  a suspense  account  in which the  unrealised interest  was entered, the same should not be  included in  the assessee!s  taxable income,  if the Income Tax  Officer was  satisfied  that  there  was  really little probability  of the  loans being repaid. (Vide C.B.R. Circular No.  37/54 dated  25.8.1924, No.  41(V-6) D of 1952 dated 6.10.1952,  CBDT!s Letter F.No. 207/10/73 ITA II dated 16.4.1973 and  RBI Circular IFD No. O.P.R. 1076/1(5) to SFCs dated 21.11.1973,  copies  whereof  were  furnished  to  the Court). Counsel  urged that  such Instructions  contained in

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these  Circulars   were  in  consonance  with  the  accepted principle that  what was chargeable under the Income Tax Act was the  real income  of an  assessee but  according to  him these Instructions  which held  field for over 53 years were changed, though  wrongly, under  fresh Circulars  dated June 20, 1978  and October 9, 1984 issued by the Central Board of Direct Taxes  whereunder such interest on doubtful or sticky loans became  includible in  the assessable  income  of  the assessee (subject  to some  relief specified  therein)  with effect from  the assessment  year 1979-80. Secondly, counsel contended that  in any  view of  the matter  in the  case of banks  and   financial  institutions   who  regularly  adopt mercantile system  of accounting  the practice  of  carrying interest on such sticky loans to !Interest Suspense Account! or  !Reserve  for  Doubtful  Interest  Account!  instead  of crediting the same to !Interest Account! or !Profit and Loss Account! is  a universally  recoginsed  practice  invariably adopted  by  them  and  being  wholly  consistent  with  the mercantile system  of accounting  the Income Tax Officer was bound to  give effect  to it  under s.  145 of the Act, and, therefore, the  treatment of  the  three  sums  representing interest on sticky loans as the 41 assessee!s income  for the  concerned assessment years would be unsustainable  in law;  and in this behalf counsel placed reliance on  the  standard  text  books  of  accountancy  of authors like  Spicer and  Pegler, Shikla  and Grewal and the Approved Text of International Accounting Standard 18.      Since the  issues raised before us have a vital bearing upon the  tax liability  and business interests and policies of serveral  financial institutions including foreign banks, six interverners,  namely,  American  Express  International Banking  Corpn.,   Mercantile  Bank   Limited  through   its successors Hongkong  & Shenghai  Banking  Corporation,  Citi Bank N.A.,  Chartered Bank,  Grindlays Bank  and  Industrial Credit & Investment Corpn. of India sought our permission to intervene in  these appeals  and we  granted  the  requisite permission in  view of the importance of the issues involved and  it  may  be  stated  that  Counsel  appearing  for  the interveners have adopted the arguments of Mr. Palkhiwala and generally supported the submissions made by him on behalf of the assessee  in these  appeals; but  special mention may be made of  the fact  that in  the written submissions filed on their behalf  it has  been categorically asserted that while maintaining their  accounts regularly  on mercantile  system each one  of these institutions in the matter of interest on doubtful or  sticky loans  invariably follow the practice of debiting such  interest to the account of concerned borrower but instead of crediting it to !Interest Account! or !Profit and Loss  Account! the  same is carried to a special account styled !Interest  Suspense Account! or !Reserve for Doubtful Interest Account!  and only  upon realisation  the  same  is credited to  Interest Account and Profit and loss Account in the year  of realisation  and is offered for taxation. It is also claimed  by some  of the  Interveners that they have an elaborate and  well controlled  system of evaluation for the purposes of  assessing the  recoverability and  position  of various  accounts  of  their  borrowers  and  the  financial condition of  each  borrower  is  periodically  reviewed  by Senior Management Personnel on the basis of detailed reports and data  collected in  regard to  each before  treating the laons  as  sticky.  Counsel  reiterated  on  behalf  of  the Intervenees that  the benefit under the earlier Circulars of C.B.R. and  R.B.I. did not depend upon the ipse dixit of the assessee but  was available only if the safeguards specified

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therein were observed and the taxing authority was satisfied on objective  materials that  the loan had become sticky and there was  really  little  probability  of  the  same  being repaid. 42      On the  other hand, counsel for the Revenue pressed for our acceptance  the view  taken by the High Court. He fairly conceded that  it is  the real  income that is chargeable to tax under  the Act  and not  any hypothetical  income of  an assessee and  that under section 28 in respect of a business the chargeability  must attach  to real  profits  and  gains arising from  the transactions  of the  previous year but he contended that  under section  5 read with section 28 of the Act the liability attaches to profits which have been either received by the assessee or which have accured to him during the year  of account  and it  is well  settled that  inncome accrues  when   it  "falls   due",  i.e.,   becomes  legally recoverable irrespective of whether actually received or not and "accrued  income" is that income which "the assessee has a legal right to receive": vide C.I.T. v. Thiagaraja Chetty, 24 I.T.R.  525 at  531 and  Morvi Industries  Ltd. v. C.I.T. Calcutta, 82  I.T.R. 835  at 840  and since  admittedly  the assessee has  been maintaining  its accounts  on  mercantile basis the  three  sums  being  interest  on  loans,  whether doubtful or  sticky, fell  due and  became  payable  to  the assessee at  the end  of each  of the three accounting years and constituted  its accrued  income  and  were,  therefore, justifiably brought  to  tax  in  the  concerned  assessment years. Counsel  for the  revenue fairly conceded that Courts have, while  imposing  the  tax  liability  under  the  Act, recognised the theory of real income by having regard to the business character  of the transactions and realities of the situation but these aspects have been taken into account for the purpose  of determining whether the income could be said to have  legally accrued or not and once it is found to have legally accrued  it is  brought to  tax. He pointed out that all the  decisions of  this Court  show that this theory has been invoked  and confined  only to  two types  of cases (a) where there  has been  a surrender  of income  which may  in theory have  accrued, and (b) where there has been diversion of income at source either under a statute or by over-riding title but  in none  of these  cases has  the aspect  of high improbability of  recovery been  regarded as  sufficient  to prevent accrual; counsel therefore urged that this theory of real income  should not  be extended  so as  to exclude from chargeability such  income  which  has  accrued  but  merely suffers  form   high  improbability   of  recovery.  Counsel submitted such  extension would  be neither  permissible nor advisable - not permissible because it goes against the very concept of  accrued income and not adyisable because if done it will  apply to  all cases  and not  merely  to  cases  of interest accruing to banks and financial 43 institutions. Moreover,  such extension  will entrench  upon section 36  (1) (vii) which provides for deduction of a debt or part thereof on its becoming bad on fulfilment of certain conditions specified  in sub-section  (2) thereof. For these reasons counsel  submitted that  the extension of the theory of  real   income  so  as  to  take  within  its  ambit  the consideration of  high  improbability  of  recovery  is  not warranted. As  regards the  earlier Circulars  of C.B.R. and R.B.I. On which reliance was placed by the assessee, counsel for the  revenue  submitted  that  these  merely  granted  a concesssion to  and conferred  no right  in  favour  of  the assessee which  could be  and has  been withdrawn  later  by

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issuing  fresh  Circulars  but  since  the  benefit  or  the concession in  favour of the assessee could not be withdrawn retrospectively,  the  withdrawal  of  concession  has  been effected prospectively from the assessment year, 1979-80.      Having regard  to the rival contentions urged before us by counsel  on either  side it  is clear  that the following questions do  arise for  our serious  consideration  on  the first issue  raised for  determination in these appeals. Did the  three   sums  representing  interest  on  sticky  loans constitute real  income of  the assessee  for the  concerned assessment years?  Had such  income really  accrued  to  the assessee for those years? Does real accrual of income depend on its  falling due  by mere  lapse of requisite contractual period at  the end  of which  it becomes  legally payable or upon the  business character  of  the  transaction  and  the realities of  the  situation?  How  far  is  the  method  of accounting  regularly   adopted  by   the   assessee   (here mercantile) relevant  for  deciding  the  question  of  real accrual? What  is the  effect of  making  debit  entries  in respect of  such interest  in the respective accounts of the concerned debtors under the mercantile system of accounting? And lastly,  can and  should the  theory of  real income  be extended  so   as  to   exclude  a  particular  income  from chargeability under the Act because of high improbability of recovery attaching to it in the concerned accounting year or years? We  would like  to deal  with these  questions in the light of decided cases.      The material provisions in regard to the computation of income of  an assessee  under the head !Profits and Gains of Business! are  to be found in sections 28 (i) 29 and 145 (1) but these  have to  be read  subject to  sec. 5  of the Act. Section 28  (i) taxes  the profits and gains of any business carried on  by the  assessee at any time during the previous year and such profits and gains are, under sec. 29 to be 44 computed in  accordance with the provisions contained in ss. 30 to  43A, that  is to  say  after  making  allowances  and deductions mentioned  in those  sections.  Section  145  (1) provides that  income chargeable under the head !Profits and Gains of  Business! shall be computed in accordance with the method of  accounting regularly  employed by  the  assessee, provided that,  in any  case where  the accounts are correct and completed  to the satisfaction of the Income-Tax Officer but the  method is  such that,  in his  opinion, the  income cannot be  properly deduced  therefrom then  the computation shall be  made upon  such basis  and in  such manner  as the Income-Tax Officer  may  determine;  but  where  he  is  not satisfied about  the  correctness  or  completeness  of  the accounts of  the assessee,  or where no method of accounting has been  regularly employed by the assessee, he can proceed to make  the assessment  to the  best of his judgment. It is well-settled, as  a result  of the Privy-Council decision in C.I.T. v.  Sarangpur Cotton Mfg. Co., 6 I.T.R. 36 at 40 that the section  clearly makes such regularly employed method of the opinion  of the  Income tax Officer, the income, profits and gains cannot properly be deduced therefrom.      Though these provisions provide for charging the income by way  of profits  and gains  of business and prescribe the manner of  computation the  question as  to at what point of time its  chargibility arises is answered by s. 5 of the Act which states  that the  total income  of a resident assessee from whatever  source derived becomes chargeable either when it is  received by  him or  when it accrues or arises to him during the  previous year.  In  other  words  taxability  is attracted even  when income has accrued and it is clear that

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the receipt  of income  is not  the sole  test of taxability under the Act; but whether on receipt basis or accrual basis it is  the real income and not any hypothetical income which may have  theoretically accrued  that is  subjected  to  tax under the  Act and  this latter aspect arising under our Act is well  settled by  decisions of  this Court  and the  High Court to which I will presently refer.      However, before  referring to  the decisions which deal with the  doctrine of  real income  it will  be desirable to indicate the  main difference  between the  two  methods  of accounting that are usually employed by business men as also to deal  with the  aspect as to how far and to what extent a method of  accounting - particularly the mercantile method - has a  bearing on the question of real accrual of income. In Dhakeswar 45 Prassad Narain Singh v. Commissioner of Income Tax, 4 I.T.R. 71 at  74 Sir  Courtney Terrell,  C.J. described  the  ’cash system’ in these words:           "According to  the system  a  record  is  kept  of           actual receipts and actual payments, entries being           made only  when money  is  actually  collected  or           disbursed and  if the  profits of the business are           accounted in  this way  the tax  is payable on the           difference   between    the   receipts   and   the           disbursements for the period in question." On  the  other  hand  the  ’mercantile  accountancy  system, otherwise known  as the ’book profits system of accountancy’ or  the   ’complete  double  entry  book-keeping’  has  been described by Sir Iqbal Ahmed, C.J. in C.I.T. v. Singari Bai, 13 I.T.R. 224 at 227, as follows:           "Under this  system the  net  profit  of  loss  is           calculated  after  taking  into  account  all  the           income and  all the  expenditure relating  to  the           period, whether  such  income  has  been  actually           received or  not and  whether such expenditure has           been actually  paid or  not. That  is to  say, the           profit computed  under this  system is  the profit           actually earned,  though not  necessarily realized           in case,  or the loss computed under the system is           loss actually  sustained, though  not  necessarily           paid in  cash. The  distinguishing feature of this           method of  accountancy  is  that  it  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 distinction  between these  two accounting  systems  has been adverted  to by  this Court in several of its decisions but I need refer only to one decision in C.I.T. Madras v. A. Krishnaswami Mudaliar  & Others,  53 I.T.R.  122  where  the distinction has  been elaborately  brought out by Shah J (as he then  was) in  the following  passage occurring  at pages 129-130 of the Report;           "Among Indian businessmen, as elsewhere, there are           current two  principal systems  of  book  keeping.           There is, firstly, the cash system in which a 46           record is  maintained of actual receipt and actual           disbursements, entries  being posted when money or           money’s worth  is actually  received, collected or           disbursed.  There  is,  secondly,  the  mercantile           system, in  which entries  are posted in the books           of account  on the  date of the transaction, i.e.,

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         on the  date on which rights accrue or liabilities           are  incurred,   irrespective  of   the  date   of           payments. For  example, when  goods  are  sold  on           credit, a  receipt entry  is posted as of the date           of sale,  although no cash is received immediately           in payment  of such  goods; and  a debit  entry is           similarly  posted   when  liability   is  incurred           although payment  on account  of such liability is           not made  at  the  time.  There  may  have  to  be           appropriate variations when this system is adopted           by  an  assessee  who  carries  on  a  profession.           Whereas under  the cash  system no account of what           are called the outstandings of the business either           at the commencement or at the close of the year is           taken, according  to the  mercantile method actual           cash receipts  during the year and the actual cash           outlays during  the year  are treated  in the same           way as  under the  cash system, but to the balance           thus arising,  there is  added the  amount of  the           outstandings not  collected at the end of the year           and from this is deducted the liabilities incurred           or accrued  but not  discharged at  the end of the           year. Both the methods are somewhat rough. In some           cases these  methods may  not give a clear picture           of the  true profits  earned and  certainly not of           taxable  profits.   The  quantum   or   allowances           permitted to be deducted under diverse heads under           section 10  (2) from the income, profits and gains           of a business would differ according to the system           adopted.  This   is  made  clear  by  defining  in           subsection (5)  the word  ’paid’ which  is used in           several clauses  of  sub-section  (2)  as  meaning           actually paid  or incurred according to the method           of accounting  upon the basis of which the profits           or gains  are computed  under  section  10.  Again           where the  cash system  is adopted,  there  is  no           question of  bad debts  or outstandings at all, in           the case  of mercantile  system against  the  book           profit some  of the  bad debts  may have to be set           off when  they  are  found  to  be  irrecoverable.           Besides the cash system 47           and the  mercantile system,  there are innumerable           other systems  of accounting  which may  be called           hybrid  or   heterogeneous  -   in  which  certain           elements and  incidents of the cash and mercantile           systems are combined." On the  aspect as  to how far and to what extent a method of accounting has  a bearing on the question of real accrual of income  the   Court  has   made  the  following  significant observation at page 128 of the Report:           "But the  section (section  13  of  the  1922  Act           equivalent to  section 145  of the  1961 Act) only           deals with  a computation  of income,  profits and           gains for  the purposes  of  sections  10  and  12           (sections 28  and 56 of the 1961 Act) and does not           purport to  enlarge or  restrict  the  content  of           taxable income, profits and gains under the Act." Obviously for  the content  of taxable  income one must have regard to  the substantive  charging provisions  of the Act. This decision,  in my  view, has  emphasised  two  important aspects in  regard to  the two methods of accounting usually employed by  business men.  In the first place the Court has pointed out  that both the methods are somewhat rough and in some cases  these methods  may not give clear picture of the

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true profits  earned and  certainly not  of taxable profits; and secondly,  whatever be  the method regularly employed by an assessee  the same  has to be adopted as the basis and is relevant only  for the purpose of the computation of income, profits and gains under sections 28 and 56 of the Act but it cannot enlarge  or  restrict  the  content  of  the  taxable income, profits  and gains  under the  Act. It is thus clear that, under  section 145,  the assessee’s  regular method of accounting determines  the mode  of  computing  the  taxable income but it does not determine or even affect the range of taxable income or the ambit of taxation. In other words, any hypothetical income  which may  have the  oretically accrued but has  not truly resulted or materialised in the concerned accounting year  cannot be  brought to charge simply because the assessee  has been  regularly employing  the  mercantile system of  accounting and  makes entries  in  his  books  in regard to such hypothetical income.      In the light of above I would recapitulate the admitted facts and  the manner in which the assessee treated or dealt with the three sums representing interest on sticky loans in 48 its books  pursuant to  the mercantile  system of accounting regularly adopted  by it.  Indisputably, the  three sums  in question  represented   the  assessee’s  income  by  way  of interest on advances made by it to some of its customers but having regard to the deteriorating financial position of the concerned parties  and the  history of  their  accounts  the assessee felt that the advances had become sticky during the concerned accounting  years inasmuch as even the recovery of the principal  amounts  had  become  highly  improbable  and extremely doubtful  in those  years;  therefore,  though  it charged such  interest by  debiting the concerned parties it did not carry it to its profit and loss account but credited the same  to a  separate account  styled ’Interest  Suspense Account’ so  as to  avoid showing unreal or inflated profits and claimed  that it  was not  taxable in  its hands as real income had not accrued to it. The facts that the advances or loans had,  during the  concerned accounting  years,  become sticky and  that  such  interest  had  not  materialised  or resulted to  the assessee  in those  years were not disputed but as  stated earlier the claim was negatived by the taxing authorities and the Tribunal on the ground that the advances or loans  had not been treated as irrecoverable or bad debts under s.  36 (1) (vii), that the aspect that the advances or loans had  become sticky  was  irrelevant,  that  since  the assessee was  following the  mercantile system of accounting such  interest  has  accrued  to  it  at  the  end  of  each accounting year  and that  the assessee had itself shown the accrual of  interest by  changing the  same to the concerned parties by  making debit entries in their accounts. The High Court also  affirmed the view that there had been accrual of the income  at the  end of  each accounting year and in that behalf laid  emphasis on the fact that the assessee had been regularly adopting  the mercantile  system of accounting and observed  that   the  assessee’s  income  will  have  to  be determined in accordance with that method. In other words it is clear  that in  coming to  the conclusion  that the three sums in question were liable to be brought to tax the taxing authorities, the Tribunal and the High Court, relying on the mercantile  system  employed  by  the  assessee,  adopted  a legalistic approach  and took  the view  that  because  such interest had  fallen due  and become  legally recoverable by the assessee  at the  end of each of the accounting years it had accrued to it, though by reason of the stickiness of the advances or  loans such interest had in fact not resulted or

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materialised  but  remained  its  hypothetical  income.  Two questions arise:  Should such  legallstics approach  prevail over 49 the doctrine  of real  income that  has been  recognised and invoked by  Courts while  imposing tax  liability under  the Act? Secondly,  can the  mercantile  system  of  accounting, though  regularly  employed,  ’determine’  accrual  of  real income?      Since the  answer  to  the  second  question  has  been already indicated  in the  earlier part  of our  judgment we shall dispose  of second  question  first.  As  regards  the mercantile system  of accounting  regularly employed  by the assessee there  are two  aspects which  we like  to  stress. First, the High Court, in my view, was in error in observing that the  assessee’s income  "will  have  to  be  determined pursuant, to  the provisions contained in the Income Tax Act 1961, in  accordance with  the accounts regularly maintained by it."  I have  already indicated  above that the method of accounting regularly  employed by  an assessee  is  relevant only for  the purpose  of computation of income, profits and gains under  s. 28  of the Act and that it cannot enlarge or restrict the content of the taxable income under the Act and that  under   s.  145   the  assessee’s  regular  method  of accounting determines  the mode  of computing taxable income but it  does not  determine or  even  effect  the  range  of taxable income  or ambit  of taxation. In other words simply because  the  assessee  has  been  regularly  employing  the mercantile system  of accounting  it would not mean that any hypothetical income which may have theoretically accrued but has not  truly resulted  to him  in the concerned accounting year can  be brought  to charge and, therefore, the question whether the three sums representing interest on sticky loans had really  accrued to the assessee or not would be a matter of substance  and cannot  be  determined  by  merely  having regard to  the method of accounting (here mercantile system) adopted by  the assessee.  Secondly it will have to be borne in mind  that this  is not  a case  where the  assessee  had ignored or  failed to  make any  entries at all in regard to such interest  on advances  or loans which had become sticky in its  books maintained  on mercantile  system but  it  had charged such  interest by debiting the accounts of concerned debtors and had designedly credited it to ’Interest Suspense Account’ instead of carrying it to ’Profit and Loss Account’ with a  view to  avoid showing unreal or inflated profits. A ’suspense account’  in book-keeping  means  "an  account  in which items  are temporarily  carried  pending  their  final disposition; it  does not  appear in  financial  statements" (vide Kohler’s  Dictionary for  Accountants, Third Edition). Since the  final disposition  of the  sums in  question  was uncertain and hung in balance these items were properly 50 carried to ’Interest Suspense Account’ and could not and did not find  a place in the financial statement like the Profit and Loss  Account. From the mere fact that such interest was charged to  the concerned debtors by making debit entries in their respective  accounts no  inference could be drawn that the assessee  had regarded  it  as  accrued  income  because simultaneously  such   interest  was  credited  to  Interest Suspense Account  and not  to Profit  and Loss  Account. The taxing authorities,  the Tribunal and the High Court clearly erred in  drawing such  inference against  the assessee.  In fact by  making the aforesaid entries and treating the three sums in  the manner  done the  assessee must  be regarded as having  demonstrably   shown  an  intention  to  treat  such

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interest as its hypothetical and not real income.      Counsel for the assessee pointed out that after all the primary purpose  of book-keeping,  whatever be the method of accounting, was  to make  a systematic  record  of  business transactions  in  a  manner  which  must  show  the  correct financial position  of a  business house at a given point of time and  reflect the  real and true profits of the business done by  it during the year of account and contended that in treating the  three sums  in question in the manner done the assessee  had   merely  followed  a  universally  recognised practice  invariably   adopted  by   banks   and   financial institutions  who  maintain  their  accounts  on  mercantile system and  what was  more this  practice accorded  with the principle that no item should be treated as income unless it has been  actually received or has accrued in the sense that there is  reasonable certainty  that it  will be realised. I find considerable  force in  this contention  of counsel for the assessee. That the practice of carrying interest on such sticky loans  to  ’Interest  Suspense  Account’  instead  of crediting the  same to  ’Interest Account’ or to ’Profit and Loss Account’  is a  universally recognised  practice and is wholly consistent  with the  mercantile system of accounting will be  clear from  the standard text books on accountancy. For instance,  in the treatise ’Advanced Accounts’ by Shukla and Grewal (Ninth Revised and Enlarged Edition 1981) a clear reference to  such practice  finds a  place in the following paragraph occurring at page 1089 under the heading ’Interest on doubtful debts’:           "Interest on  doubtful debts  should be debited to           the loan  account  concerned  but  should  not  be           credited to Interest Account. Instead it should be 51           credited to  Interest  Suspense  Account.  To  the           extent the  interest  is  received  in  cash,  the           Interest Suspense  Accounts should  be transferred           to Interest  Account; the  remaining amount should           be closed  by transfer  to the  Loan Account. This           treatment accords  with the principle that no item           should be  treated as  income unless  it has  been           received or  there is  a reasonable certainty that           it will be realised." Similarly in  Spicer and  Pegler’s ’Practical  Auditing’  by W.W. Bigg  (Fourth Indian  Edition  by  S.V.  Ghatalia)  the learned  author   has  suggested  that  instead  of  leaving irrecoverable interest  on doubtful  loans  out  of  account altogether the  practice of  charging such  interest to  the parties concerned  but crediting it to the Interest Suspense Account is more appropriate for reflecting the correct state of affairs  and  the  true  profits.  The  relevant  passage occurring at pages 186-187 runs thus:           "Where interest has not been paid, it is sometimes           left out  of account altogether. This prevents the           possibility  of   irrecoverable   interest   being           credited to revenue, and distributed as profit. On           the other hand, this treatment does not record the           actual state  of the loan account, and in the case           of banks  and other  concerns whose business it is           to  advance  money,  it  is  usual  to  find  that           interest is  regularly charged  up, but  when  its           recovery is doubtful, the amount thereof is either           fully provided  against or  taken to the credit of           an Interest  Suspense Account and carried forward,           and  not   treated  as   profit   until   actually           received." Reference may  also be  made to  the Approved  Text  of  the

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’International Accounting  Standard 18’  (Supplement to ’The Management Accountant’,  December 1982) a publication of the International Accounting Standards Committee. The concept of revenue recognition is explained thus in para 5:"           "Revenue recognition is mainly concerned with when           revenue is  recognised in  the income statement of           an enterprise.  The amount of revenue arising on a           transaction is  usually  determined  by  agreement           between the parties involved in the transaction. 52           When    uncertainties    exist    regarding    the           determination of  the amount,  or  its  associated           costs these uncertainties may influence the timing           of revenue recognition." The effect  of uncertainties on revenue recognition has been set out in paragraphs 16 to 27 and para 25 is material which runs thus:           "Revenues  arising  from  the  use  by  others  of           enterprise resources  yielding interest, royalties           and dividends  should only  be recognised  when no           significant uncertainty  as  to  measurability  or           collectability exists." In  other   words  according   to  International  Accounting Standard 18  if significant uncertainty as to collectability of interest exists such revenue should not be recognised. In view of  what has  been stated  in  the  standard  books  on accountancy as also in the International Accounting Standard 18 I  am clearly of the view that in the case of interest on sticky loans  the practice  of debiting  the accounts of the concerned debtors  with such  interest and carrying the same to ’Interest  Suspense  Account’  instead  of  to  ’Interest Account’ or  ’Profit and  Loss Account’ is a well recognised and accepted  practice of commercial accountancy, that it is wholly consistent  with mercantile  method of accounting and that it  prevents  the  wrong  crediting  and  improper  and illegal distribution  or remittance  of inflated  and unreal profits and by making the appropriate entries following such practice the  assessee had  clearly indicated that the three sums in  question being interest on sticky loans constituted its hypothetical income and not real income.      Turning to  the first question it is true that under s. 5  taxabillity  is  attracted  not  merely  when  income  is actually received  but also  when it has ’accrued’ and it is also true, as has been explained by this Court in Thiagaraja Chetty’s case  (supra) and  Morvi Industries’  case  (supra) that income accrues when it ’falls due’, that is to say when it becomes legally recoverable irrespective of whether it is actually received or not and ’accrued income’ is that income which  ’the   assessee  has   a  legal  right  to  receive’. Incidentally it  may be  stated that in both of these cases, where the  legal aspect  of accrual  has been  explained, no question of  applying the  doctrine  of  real  income  could arise; for, in the former case 53 after the  commission payable  to the  managing  agents  had accrued at  the end  of  the  accounting  year  the  managed company had,  instead of  paying it,  kept it  in a suspense account pending settlement of a dispute in regard to another debt owed  to it  by the  managing  agents  (which  proposed settlement was  ultimately rejected) and the Court held that such keeping  it in  the suspense account pending settlement of another indebtedness would not prevent its accrual to the managing agents,  while  in  the  other  case  a  unilateral relinquishment of  the commission by the managing agents was after its  accrual and  hence the  Court ruled that it could

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not escape  liability to  tax. While  the  legal  aspect  of accrual thus  holds good  this Court  in C.I.T.  v.  Shoorji Vallabhdas & Co. 46 I.T.R. 144 has enuciated the doctrine of real income in these terms:           "Income-tax is  a levy  on income.  No doubt,  the           Income-tax Act  takes into  account two  points of           time at  which the  liability to tax is attracted,           via., the  accrual of  the income  or its receipt;           but the  substance of the matter is the income. If           income does  not result  at all, there cannot be a           tax, even though in book-keeping, an entry is made           about  a   hypothetical  income,  which  does  not           materialise.  Where  income  has,  in  fact,  been           received and  is subsequently  given  up  in  such           circumstances that  it remains  the income  of the           recipient, even  though given  up, the  tax may be           payable. Where,  however, the  income can  be said           not to  have resulted  at all,  there is obviously           neither accrual nor receipt of income, even though           an  entry   to  that   effect  might,  in  certain           circumstances, have  been made  in  the  books  of           account."                                          (Emphasis supplied) The above  observations were  made in  the context  of these facts. The  assessee-firm was  the  managing  agent  of  two shipping companies;  between April  1, 1947 and December 31, 1947  an  amount  of  Rs.  1,71,885  from  one  company  and Rs.2,56,815  from  the  other  company  became  due  to  the assessee as  commission @  10 per  cent under  the  managing agency agreement  and in its books the assessee had credited these amounts  to itself  and debited  them to  the  managed companies. In  November, 1947  the assessee  desired to have the  managing  agency  transfered  to  two  private  limited companies and in this connection agreed in 54 December 1948  to accept  2-1/2 per  cent as  commission and gave up  75 per  cent of its earnings. The department sought to assess the amounts of Rs. 1,36,903 and Rs. 2,00,625 being the 75  per cent  which the  assessee have  given up, on the ground that commission at 10 per cent had already accrued to the assessee in the year of account which ended on March 31, 1948 and  the agreement in December 1948, after the close of the previous  year, to give up a portion of income could not save that  portion from  liability to income-tax. Negativing the contention  this  Court,  in  agreement  with  the  High Court’s view, held that the subsequent agreement has altered the rate  of commission  in such a way as to make the income which really accrued to the assessee different from what had been entered in the books of account and that this was not a case of a gift by the assessee to the managed companies of a portion  of   income  which  had  already  accrued,  but  an agreement to  receive a  lesser remuneration  than what  had been agreed  upon. The  Court relied  upon the fact that the assessee had  in fact  received only  the lesser  amount  in spite of  the entries  in the  accounts books  and held that such lesser amount alone was taxable.      A large  number of  decisions rendered by this Court as well as  by the High Courts were cited at the bar by Counsel on the  either side  in which  this aforesaid theory of real income has  been invoked  and applied  and in  some of  them emphasis has  been laid  on the  aspect that  accrual is the matter of  substance to  be decided on commercial principles having regard  to the business character of the transactions and the  realities  of  the  situation.  After  having  gone through  these   decisions  I   am  in  agreement  with  the

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submission of the learned counsel for the revenue that these decisions involving the application of the concept fall into two groups:  (a) cases  where there  has been a surrender or relinquishment of income that may have theoretically accrued and (b)  cases where  these has  been diversion of income at source either  under a  statute or by over riding title; but in  both  types  of  cases  the  Court’s  endeavour  was  to determine whether  there was  accrual of  real income having regard to the realities or specialities of the situation. It is not  necessary to  deal  with  each  and  every  decision falling under  either one  or the  other group but confining attention to  the decision  of this Court it will suffice to indicate  that  in  the  former  group  fall  the  following decisions, namely  C.I.T. v. Hari Vallabhadas Kalidas & Co., 39 I.T.R. 1, C.I.T. v. Chamanlal Mangaldas & Co. and 55 C.I.T. v.  Mangaldas Girdhardas  Parekh Ltd.,  39 I.T.R.  8, C.I.T. v. Messrs Shoorji Vallabhadas and Co. (supra), C.I.T. Madhya Pradesh  v. Kalooram  Govindram, 57  I.T.R.  630  and C.I.T. v.  Birla Gwalior  (P) Ltd., 89 I.T.R. 266, while the decision in Poona Electric Supply Co. Ltd. v. C.I.T. Bombay, 57 I.T.R.  521, falls in the latter group. Since the instant case is  not one  of diversion  of income  at source  either under a  statute or  by over-riding title I need dilate only on the decisions in the former group.      As regards  the decisions  falling in group (a) I would like to  point out  that the  ratio of  all these  decisions clearly  is   that  where   income  or   part  thereof   has theoretically accrued  but has  been, either unilaterally or as a result of bilateral arrangement, voluntary relinquished or surrendered  by the  assessee before its accrual the same cannot be regarded as real income of the assessee and cannot be brought  to tax,  and such  conclusion has  been  reached having regard  to the business character of the transactions and the realities of the situation notwithstanding that some entries have been made in the assessee’s books maintained in the mercantile system. The decision of the Bombay High Court in H.M.  Kashiparekh Co.’s  case 39  I.T.R. 706 is a typical instance  in  point.  The  assessee,  which  maintained  its accounts in the mercantile system, was the managing agent of a paper mill company; under the managing agency agreement it was under a duty to forego up to one-third of its commission where the profits of the managed company were not sufficient to pay  a divident  of 6  percent; for  the accounting  year ending March  31, 1950  the assessee  earned a commission of Rs. 1,17,644  but as  a result  of resolutions passed by the managed company  and the  assessee company the assessee gave up a  sum of  Rs. 97,000  (Rs.57785 over and above Rs. 39215 which it  was bound  to forego) in December 1950. Though the Appellate Tribunal found that the excess amount of Rs. 57785 had also  been given up for reasons of commercial expediency it held  that the  maximum amount which could be foregone by the assessee  was only  Rs. 39215 and therefore included the excess amount  of Rs.  57785 in  the taxable  income.  On  a Reference, the  High Court  held that it was the real income of the  assessee company  for the  accounting year  that was liable to  tax, that the real income could not be arrived at without taking  into account  the  amount  foregone  by  the assessee and  that in  ascertaining the  real income  of the fact that the assessee followed mercantile system of account did not have any bearing. The Court further held that the 56 accrual of commission, the making of the accounts, the legal obligation to  give  up  part  of  the  commission  and  the foregoing of  the commission  at that  time of the making of

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the  accounts   were  not  disjointed  facts;  there  was  a dovetailing about  them  which  could  not  be  ignored  and therefore the  real income  of the assessee was Rs.27644 and the amount of Rs.97000 foregone by the assessee could not be included  in  the  real  income  of  the  assessee  for  the accounting year.      It will  be significant  to  mention  that  during  the hearing of  the Reference  counsel for  the revenue raised a contention that  even if  the amount  of Rs.  57785 had been foregone by  the assessee  company on  grounds of commercial expediency that  was not  done in  the accounting year which ended on  March 31, 1950 but it was done in December 1950 as a result  of two  resolutions, one  passed  by  the  managed company and  the other  passed by  the assessee  company and that  since   admittedly  the  assessee  was  following  the mercantile system  of accounting  it could  not avail of the benefit of  the doctrine  of real income where the income by way of  the managing  agency commission had been credited in the books in the year of account and had been surrendered by it in  the next  year; in  other words  it was  specifically urged that  if the surrender was not made and entered in the books in  the same  year no  question of  real income  could arise and  in this  behalf counsel  relied  upon  the  well- settled rule  that for  purposes of income-tax each year was required to  be regarded  as a  distinct and  self-contained unit. Apropos this contention the Court observed thus:           "The two  rules that  income-tax is  annual in its           structure meaning  thereby  that  for  computation           each year  is a  distinct self-contained  unit and           the other  that the income to be taxed is the real           income of  the assessee  do not  seem to  us to be           incompatible or irreconcilable. Mr. Joshi (counsel           for the revenue) also is not prepared to go so far           as that  and has  fairly stated  that there  is no           antithesis between  the two  rules. The facts of a           case may  present some  difficulty in applying the           rules by  the conflict  would, in  our opinion, be           rather apparent  than real.  The facts  of a given           case may  create the  impression of  a  discrepant           situation but  the  apparent  discrepancy  can  be           solved in a manner not inconsistent with the basic           concepts  underlying   the  two   rules.  In   our           judgment, 57           they permit  of harmonious application, though the           application is  to a  degree must  depend  on  the           circumstances  of  each  case.  Some  propositions           could be  formulated but whether a general formula           applicable to all circumstances could be hit on we           rather doubt.           Though it  may not  be  possible  to  prescribe  a           general formula  which successfully  compose every           conflicting situation,  the position  in law seems           clear to  us that  in applying  the two  rules  to           particular transactions  regard must be had to the           true legal  rights and  the true situation. A fair           interpretation  of   the   transaction   and   the           situation would  lead to  a preferable  and, if we           may  say   so,  a   correct  solution  than  sheer           adherence to  one  rule  and  discounting  of  the           other."           At page  720 of  the Report  the Court  went on to           observe thus:      "In the course of his argument, learned counsel for the Revenue stated  that there  must have  been entries  in  the

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books of  the managed  company and  the managing  company in consonance  with   clause   5   of   the   managing   agency agreement.............. we  shall  proceed  on  the  footing that, the  assessee company  having followed  the mercantile system of  account, there must have been entries made in its books in the accounting year in respect of the amount of the commission. In  our judgment,  we would  not be justified in attaching any particular importance in this case to the fact that the  company followed the mercantile system of account. That would  not have  any particular bearing in applying the principle  of  real  income  to  the  facts  of  this  case. Incidentally, we  may observe  that we ourselves pointed out in  the  case  of  Commissioner  of  Income-tax  v.  Shoorji Vallabhadas &  Co. that  the  question  whether  the  income accrued or  not is  not a  mere matter  of  cogency  of  the entries made  in the  account books  of the  assessee but is essentially one  of substance and of the real nature of what happened; a  mere  book  entry  is  not  conclusive  of  the question whether the assessee had become entitled to the 58           sums or not. It may also be mentioned that in that           case we were dealing with an assessee who followed           the mercantile  system  of  account.  The  crucial           question before  us, therefore, is whether the two           facts, one  the amount  of  Rs.  1,17,644.4  annas           which would  have become  payable to  the managing           company but  for the  surrender and  the factus of           surrender, are  to be  isolated or  treated as  of           cogency  in  determining  the  actual  accrual  of           income, by  which we  mean the  real income of the           assessee company.  If the  fact  of  foregoing  or           surrendering the amount of Rs. 57,000 odd is to be           regarded as  of cogency  in  the  context  of  the           present  point   of  real  income  and  if  it  be           remembered that the surrender was made at the time           of ascertaining  the  quantum  of  the  commission           payable to  the assessee company and further if it           be remembered,  as now found by the Tribunal, that           the surrender  was made  bona fide  and on grounds           solely of  commercial expediency,  it  seems  very           difficult  to   us  to  see  how  the  Revenue  is           justified in  contending that  the real  income of           the assessee  was  something  different  than  the           amount of  Rs. 20,000.  (Sic  R.27644)  which  was           shown by  it at  the time  of  assessment  as  its           income from managing agency commission."      The Court further expressed the view that the principle of real  income was  not to  be so subordinated as to amount virtually to a negation of it when a surrender or concession or rebate  in respect of managing agency commission is made, agreed to  or given  up on grounds of commercial expediency, simply because  it takes  place some time after the close of the accounting  year and  that in  examining any transaction and situation  of this  nature the  Court  would  have  more regard to the reality and speciality of the situation rather than the  purely theoretical or doctrinaire aspect of it and it will  lay greater  emphasis on the business aspect of the matter viewed  as a  whole when  that can  be  done  without disregarding the  decision of the Bombay High Court has been fully approved  by this  Court in  Birla Gwalior  (P) Ltd.’s case (supra).      It will  thus be  clear that  even under the mercantile system of accounting whenever adopted it is only the accrual of real income which is chargeable to tax, that accrual is a matter of  substance  and  that  it  is  to  be  decided  on

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commercial 59 principles having  regard to  the business  character of the transactions and  the  realities  and  specialities  of  the situation  and  cannot  be  determined  by  adopting  purely theoretical  or  doctrinaire  or  legalistic  approach.  If, therefore, for  the purpose of determining whether there has been accrual  of real  income or  not regard is to be had to the business character of the transactions and the realities and  specialities   of  the   situation  in   preference  to theoretical, doctrinaire  or legalistic  approach I  fail to appreciate  why   interest  on   sticky  loans,   which  has theoretically accrued  but has  not  factually  resulted  or materialised at  all to  an assessee hypothetical income and not real  income? There  is no  reason  why  the  factum  of stickiness of  loans  operating  throughout  the  accounting period or  periods, not  on the  basis of mere ipse dixit of the assessee  but on  being objectively  established to  the satisfaction of  the taxing  authorities by reference to the facts showing  the deteriorating  financial position  of the concerned debtors  and the  history of their accounts should not have  the effect  of preventing  the accrual of interest thereon  as  real  income  to  the  assessee?  If  voluntary relinquishment or  surrender of  income done unilaterally or as a  result of  bilateral arrangement  can prevent its real accrual there  is no  reason why the factum of stickiness of loans objectively  established should not prevent accrual of interest thereon  as real income. In fact in the former case considerations  of   commercial  expediency   could   be   a motivating force  behind such  voluntary  relinquishment  or surrender of  the income resulting in its non-accrual but in the  latter   case  the   non-accrual  would   be   due   to circumstances  beyond   the  assessee’s   control.   I   am, therefore, clearly  of  the  view  that  the  stickiness  of advances   or   loans   objectively   established   to   the satisfaction of  the taxing  authorities by producing proper material, is  sufficient to  prevent the accrual of interest thereon  as  real  income  and  would  have  the  effect  of rendering such  income hypothetical  and the  same cannot be brought to tax. In my view under the Income Tax Act in order that income  should accrue  it should not merely fall due or become legally  recoverable but should also be factually and practically realisable  during the accounting year or years. In other  words mere  non-receipt  of  income,  when  it  is reasonably realisable,  will not  affect accrual but factual or practical unrealisability thereof may prevent its accrual depending upon  the facts  and circumstances  attending upon the transaction. 60      Counsel for the revenue raised two objections to extend the  theory   of  real   income  so   as  to   exclude  from chargeability the interest on sticky loans merely because it suffers from  high improbability  of recovery.  In the first place he  urged that the Act contains no provision excluding or deducting  such interest  from computation  of income and the only  provision for deduction of debts is to be found in s. 36  (1) (vii)  where under debts which are established to have become  irrecoverable and  bad in the previous year are permitted to be deducted on fulfilment of certain conditions specified in  sub-section (2)  and as  such the extension of the theory  of real  income as sought would entrench upon s. 36 (1)  (vi),Secondly, it was urged that such extension will be ill-advised  inasmuch as, if done, it will apply to cases of interest  accruing to all money-lenders and not merely to cases  of   interest  accruing   to  banks   and   financial

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institutions. As  regards the  first objection  the argument amounts to saying that the exclusion or deduction in respect of irrecoverable  and bad  debts under  s. 36 (1) (vii) read with the  conditions mentioned  in sub-sec.  (2) proceeds on the basis  that in  substance such  debts do  not constitute real income  of the  assessee  and  therefore  exclusion  of interest on  sticky loans  from computation  of  income  for which there  is no provision in the Act and that too without any conditions  would impinge  upon the  specific  provision contained in  s. 36 (1) (vii) read with sub-section (2). The answer to this objection is that it is not as if that in the absence of some specific provision exclusion of hypothetical income cannot be done; in fact such exclusion rests not upon any slippery  or slushy  ground but  upon the principle that under the Act chargeability is attracted only to real income and in  this behalf it will be pertinent to mention that the provision for  exclusion  or  deduction  of  bad  debts  was introduced in  the income  tax law  (the 1922  Act) for  the first time  in 1939  but even prior to the insertion of such provision in the 1922 Act the Privy Council in C.I.T. v. Sir S.M. Chitnavis, 6 I.T. Cases 453 had, on the basis of ss. 10 and 13  of the  1922 Act,  ruled that  such bad  debts  were necessarily allowable  as  deduction  on  grounds  of  first principles of  accountancy. At  page 457  of the  Report the Privy Council  have observed:  "Although the  Act nowhere in terms authorises  the deduction  of bad debts of a business, such  a   deduction  is   necessarily  allowable.  What  are chargeable to  income-tax in  respect of  a business are the profits and  gains of a year; and in assessing the amount of the profits and gains of a year 61 account must  necessarily be  taken of  all losses incurred, otherwise you  would not  arrive at  the  true  porfits  and gains." Moreover,  there is  a clear  distinction between an irrecoverable loan  and a sticky loan; the former would be a bad debt  in respect  whereof the  chances of  recovery  are almost nil  having been  written off  the same  can form the subject matter  of a  deduction under  s. 36 (1) (vii) while the latter is a loan to which a high degree of improbability of recovery  attaches in  a particular  year or years due to which interest  thereon becomes  hypothetical income and not real income  during the said year or years and therefore, it cannot be  brought to  tax, though  if realised subsequently the same  could be  and ought  to be brought to tax, if this distinction is  borne in  mind no question of impinging upon the provision  contained in  s. 36  (1) (vii) read with sub- section (2) can arise by extending the theory of real income to the interest on sticky loans.      As  regards  the  second  objection,  if  on  principle interest on  sticky loans  is merely hypothetical income and is not  real income  and is  on that  account to be excluded from computation of income we fail to see why the benefit of this principle under the theory of real income should not be available to  private  money-lenders.  The  theory  of  real income must  apply to  all cases  irrespective  of  who  the assessee is. All that is required to be ensured is that like the banks  and financial institutions the money-lenders must also establish  to the  satisfaction of the taxing authority that the  loans in question had in fact become sticky during the concerned year or years by producing proper material and that they  have invariably followed the practice of carrying the interest  of such  loans to Interest Suspense Account in stead of  crediting the same to Interest Account or Profit & Loss Account  with the  additional safeguard of offering the same for  taxation if  and when it is subsequently realised.

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It will  be pertinent to mention in this connection that the earlier Circulars issued by the Central Board of Revenue and Reserve Bank  of India (vide C.B.R. Circular No. 37/54 dated 25.8.1924, No.  41 (V-6)  D of  1952 dated 6.10.1952, CBDT’s Letter F.No.  207/10/73  ITA  II  dated  16.4.1973  and  RBI Circular IFD No. O.P.R. 1076/1 (5) to SFCs dated 21.11.1973) which conferred  the benefit  of excluding  such interest on sticky loans  albeit by way of concession were applicable to private money  lenders also.  In the  circumstances both the objections are liable to be rejected.      I may  now deal  with the decisions of the High Courts. Directly on  the point  at issue  there are  five  decisions which 62 we need  consider. Out  of these  counsel for  the  assessee relied upon three decisions, two of the Madras High Court in Motor Credit  Co. case,  and Devi  Films case and one of the Punjab &  Haryana  High  Court  in  Ferozepur  Finance  case (supra) where  a view has been taken that interest on sticky loans being  hypothetical and  not  real  income  should  be excluded from the computation of the assessee’s income while counsel for the revenue relied upon two decisions one of the Bombay High Court in C.I.T. v. Confinance Ltd. 89 I.T.R. 292 and the  other of  the Calcutta High Court in James Finlay & Co. v.  C.I.T. 137  I.T.R. 698 as both these apparently seem to take a contrary view.      I shall  first deal with two decisions on which counsel for the  revenue placed  reliance. In  C.I.T. v.  Confinance Ltd. the assessee was carrying on money lending business and banking  business   and  followed   mercantile   system   of accounting. For  the accounting  year ending  March 31, 1959 the assessee stated that no credit was taken in its balance- sheet in respect of interest on several loans advanced by it as interest had remained unpaid from March 31, 1956. For the assessment years  1959-60 and 1960-61 interest in respect of amounts due by debtors amounting to Rs. 9,275 and Rs. 13,033 respectively was brought to tax by the I.T.O. and A.A.C. The Tribunal reversed  the orders on the ground that the records showed that  there had  hardly been any receipts of interest for a  number of  years past. On a reference, the High Court reversed the  Tribunal’s view  and held  that the facts that there were  hardly any  receipts  in  respect  of  items  of interest or  that the  bona fides  of the  assessee  in  not charging interest  was not disputed were circumstances which by themselves  were in  sufficient to support the conclusion that there  was no  real  income  in  respect  of  items  of interest inasmuch  as none  of the  debts due by the several debtors was  written off by the assessee and no evidence was produced to  show that  interest in respect of the debts was given up and therefore the two sums were properly includible in the  total income  of the assessee for the two assessment years respectively.  From the  judgment we find that counsel for the assessee sought to apply the doctrine of real income as expounded  in Kashiparekh’s case to the facts of the case but  the  High  Court  declined  to  do  so  by  adopting  a legalistic approach  that the  assessee had  been  following mercantile  system  of  accounting  that  the  interest  had accrued  and  further  laid  considerable  emphasis  on  two aspects, namely,  that none  of the debts due by the several debtors was written off by the 63 assessee and  no evidence was produced to show that interest in respect  of the  debts was  given up. In my view the High Court failed  to appreciate  that the  method of  accounting employed by  an  assessee  merely  determined  the  mode  of

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computing the income and not the range of taxable income and further failed to notice that there could be and was a clear distinction between  an irrecoverable  or a  bad debt on the one hand  the sticky  loan on  the other  to which  we  have adverted earlier.      In James  Finlay’s case  decided by  the Calcutta  High Court the  items of  interest receivable from two parties on advances made  to them  were  sought  to  be  excluded  from computation of  income of  the assessee  for 1970-71  on the ground that  since 1.1.1968  the  assessee  had  decided  to change its  method of  accounting in  respect  of  interest, which was doubtful of recovery, by crediting the same to the Suspense Account  and also  on the  ground that  before  the closing of  the books  of account of the relevant accounting year  the   assessee  had  adbandoned  its  claim  for  such interest. The  High Court  held that  there was no change in the mercantile  system of accounting that had all along been empolyed by  the assessee,  that the  transfer of  items  of interest to Suspense Account could not be termed as a change in the  method of  accounting and therefore the amounts were assessable on accrual basis; as regards the other ground the High  Court   held  that  though  there  was  difficulty  in realising the  interest in  the year of account there was no material to  show that  there was  any  agreement  with  the debtors to  waive the interest or to keep it in the Suspense Account and  hence the claim for interest had not been given up. In  our view the decision mainly turned upon whether the assessee had changed its method of accounting or not and the finding was  it has  not and  as far  as the  theory of real income is concerned the Court did not reject the same but on facts came  to the  conclusion that  it was  not  applicable inasmuch as the claim for interest had not been relinquished or given up.      On the  other hand  in the  three  decisions  on  which counsel for the assessee relied two High Courts have invoked and applied  the theory  of real income to cases of interest on sticky  loans and taken the view that such interest being hypothetical  and   not  real   is  not  includible  in  the assessable income  of the assessee. Only one decision may be referred to  in detail.  In the  Motor Credit  Co’s case the assessee in  the course  of its  business as  financiers for purchase of  motor vehicles  advanced, under a hire purchase agreement, moneys  to two firms which were plying buses. The routes of these two 64 firms  having   been  taken  over  by  the  State  Transport Corporation, the  firms defaulted in making payments of hire purchase  instalments,   and  consequently  the  buses  were seized. As  the assessee  company was advised that there was no prospect  of recovering  even the principal amount it did not credit  the interest  on the  outstandings from  the two firms even  though it  was adopting the mercantile system of accounting. The  ITO, however,  included a sum of Rs. 56,163 by way  of accrued  interest on the amounts outstanding from these two  firms, The AAC deleted the addition. The Tribunal held that  the assessee  could not  have expected to get any interest income on the outstandings found due from two firms and it  would be  wholly unrealistic  on  the  part  of  the assessee  to  take  credit  from  the  interest  income  and consequently confirmed  the AAC’s  order. On  a reference at the instance  of the Commissioner the Madras High court held that the  Tribunal was  right in  its conclusion that though the assessee had adopted the mercantile system of accounting no interest income could be assessed in its hands on accrual basis and  it would  be very  unrealistic on the part of the

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assessee to  take credit  for the  highly illusory interest. Following the  decision of  this Court in Shoorji Vallabhdas Co’s case and of the Bombay High Court in Kashiparekh’s case the High  Court took  the view  that  the  regular  mode  of accounting merely  determined  the  mode  of  computing  the taxable income  and the  point of  time  at  which  the  tax liability was attracted and it could not determine or affect the range  of taxable  income or  the ambit  of taxation. It further observed that it was not the hypothetical accrual of income based on the mercantile system of accounting followed by the  assessee that  had to be taken into account but what should be  considered was  whether  the  income  had  really materialised or  resulted to  the assessee and that question had to  be  considered  with  reference  to  commercial  and business realities  of the  situation in  which the assessee had been  placed and  not with  reference to  his system  of accounting and  held that  since  there  was  not  even  the remotest possibility of any interest income materialising in favour of  the assessee  in respect  of the outstandings for the accounting  year relevant  to  the  assessment  year  in question no  liability  to  tax  could  be  imposed  on  the assessee. To  the same effect are the other two decisions in Devi Films  case and Ferozepur Finance case. I approve these three decisions.      In view  of my  conclusion that  this  theory  of  real income could be and should be extended to interest on sticky loans and 65 that on principle such interest being hypothetical cannot be brought to  tax it  is unnecessary  to deal with the earlier Circulars of  the Central  Board of  Revenue and the Reserve Bank of  India all of which were in the nature of concession granted to an assessee according to counsel for the revenue.      Having regard  to the above discussion it is clear that the three  sums representing  interest on sticky advances in the instant  case being  hypothetical and not real income of the assessee  could not  be brought  to tax  for  the  three concerned assessment  years and we answer the first question in the  negative in  favour of  the assessee and against the revenue. Of  course it goest without saying that if and when these sums or any part thereof are realised subsequently the same could be brought to tax in the year of realisation.      The second  question raised  for our  determination  in these appeals  relates to  the taxability  of  Rs.  1,66,128 which  represents   the  exchange   difference  arising   on devaluation of  the Indian  Rupee on  August 6, 1966 and the question relates  to the  assessement year 1967-68 only. The facts giving  rise to the question are these. Admittedly the business of the assessee-bank included buying and selling of foreign exchange  and therefore any foreign currency held by it would  be its  stock-in-trade and  if foreign  currencies bought at  the predevaluation  rate of exchange were sold at post devaluation rate of exchange resulting in a surplus the same would  be its  business receipt  or revenue receipt and therefore  liable  to  tax  as  part  of  business  profits. Indisputably, just  before the  devaluation  of  the  Indian Rupee on  August 6,  1966  the  assessee-bank  held  foreign exchange by  way  of  cash  balances  available  with  their foreign correspondents,  forward contracts, items in transit etc., amounting  to L-33,780,76 in US Dollars and L-9552.0.2 in Sterling  which when converted back to Rupees at the post devaluation rates  gave rise  to a  profit of  57.5% or  Rs. 1,66,128 in the transaction; the assessee-bank credited this surplus   to    an   account   designated   "Provision   for Contingencies". It  was contended  on behalf of the assessee

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before the  lower taxing authorities that this profit should not be  taxed as it was of a casual and nonrecurring nature. The contention  was negatived  by  the  authorities  on  the ground that  even assuming, without conceding, that it was a windfall and,  therefore, of  a casual  nature the  same had arisen from  the business  activities of  the  assessee-bank and, therefore, was not exempt but was liable to tax. Before the Appellate  Tribunal an  attempt was  made by counsel for the assessee-bank  to contend that the cash balance in terms of 66 dollars and  sterlings at  the end of the accounting period, i.e., on  December 31,  1966 was higher than that as existed on the  crucial date, namely, August 6, 1966 and, therefore, this precluded  any inference  that the stock of dollars and sterlings that  existed on  the devaluation  date  had  been converted into  Indian currency  thus resulting  in profits. The Tribunal  rejected the contention as being without force inasmuch as  the assessee-bank  had  revalued  the  cost  of foreign exchange  in terms  of rupees  as  on  the  date  of devaluation to  bring it  on par  with the  post-devaluation rate by  giving a corresponding credit to the "Provision for Contingencies" thus  treating the surplus resulting from the fluctuation of exchange rate as its income and the mere fact that  the  same  had  been  carried  to  the  account  style "Provision  for   Contingencies"  did  not  alter  the  true character of  the transaction.  The High Court confirmed the ultimate  conclusion   of  the  Tribunal  by  answering  the relevant question referred to it in favour of the Revenue.      Counsel for  the assessee fairly conceded two positions arising in  the case.  In the  first place  he conceded that foreign exchange  was  held  by  the  assessee-bank  as  its stockin-trade and  he further conceded that any sale of such stock-in-trade must  result in  business income but he urged that if  the stock-in-trade  remains unused  and unsold  its notional appreciation or book appreciation in value does not result in taxable profit (vide C.I.T. v. Mughal Line Ltd. 46 I.T.R. 590,  and according  to him this is what had happened in the  instant case. According to counsel the fact that the stock-in-trade in terms of foreign currency that was held by the assessee just prior to the date of devaluation was shown not to  have been  depleted between  the date of devaluation and December 31, 1966 (the end of accounting period) clearly suggested  that   the  stock-in-trade   initially  held  had remained  unused  and  unsold  during  this  entire  period, especially when the stock-in-trade held on December 31, 1966 was shown  to be  higher than the one held just prior to the devaluation date;  and therefore  it was  a case  of a  mere nominal appreciation  or book  appreciation in  the value of the stock  and as such the same could not be brought to tax. There can be no dispute with regard to the principle that if the stock-in-trade  remains unused  or unsold  the mere book appreciation in  the value  thereof cannot be brought to tax but on  the facts  requisite to  sustain the proposition the assessee-bank does not seem to stand on any firm footing. In the first place by carrying the surplus resulting 67 from the  devaluation of  the Indian  rupee  to  an  account designated "Provision  for Contingencies"  the assessee bank itself could be said to have clearly treated such surplus as its business  income. Secondly,  the AAC  in  his  appellate order has  recorded a  categorical finding that the stock in trade in  terms of foreign currency was sold and used by the assessee in  its normal  banking business.  This is what the AAC has observed:

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         "What is  important is  that the profit on account           of the  difference in  exchange rate  should  have           arisen in  the course of trading operations of the           bank. There  is no  dobut that  it did so arise in           the instant  case. The  bank acquired and sold the           foreign exchange  assets in  course of  its normal           banking business and therefore, the profit arising           out of the fluctuation in exchange rates, however,           large  and   however  unexpected   any  particular           fluctuation may  be, arose  in the  course of  and           incidental to such business of the bank." Having regard  to the  aforesaid factual  position I confirm the High  Court’s view  that the  second question  has to be answered in  the affirmative  in favour  of the  Revenue and against the assessee.      In the  result I  would allow  the appeals in so far as the first  question is  concerned and  dismiss the  same  as regards the second question. In the circumstances there will be no order as to costs.      SABYASACHI MUKHARJI,J.  These  appeals  by  certificate arise from  the decision  of the  High Court  of  Kerala  in respect of the assessment years 1965-66, 1966-67 and 1967-68 relating to  the previous  calendar year 1964, 1965 and 1966 respectively. The  following two  questions are  involved in these appeals:           (1) Whether, on the facts and in the circumstances           of  the   case,  the   addition  of  the  sums  of           Rs.67,170. Rs. 47,777. and Rs. 57,889 representing           interest on  ’sticky’ advances  as income  for the           assessment  years  1965-66,  1966-67  and  1967-68           respectively was justified in law?           (2) Whether  on the facts and in the circumstances           of the case, the exchange difference of Rs. 68           1,66,128 arising  on  revaluation  of  the  Indian           rupee on 6.6.1966 was rightly treated as income of           the assessment year 1967-68?      In view of the categorical findings of fact recorded by the Tax  authorities and  the Tribunal  and mentioned in the judgment of  Tulzapurkar, J.,  I am  in respectful agreement with the  opinion of Tulzapurkar, J. that the High Court was right and  the second  question  must  be  answered  in  the affirmative and in favour of the revenue, and the appeals on this aspect must be dismissed.      With regard  to the first question, with respect, it is not possible to agree with the reasoning and the conclusions arrived at  by Tulzapurkar,  J.,  in  the  judgment.  It  is necesary for  this reason  to reiterate  in brief  the facts relating to the first question. The assessee is a subsidiary bank of  the State Bank of India. It used to maintain in the relevant accounting years its accounts in mercantile system; therefore, entries  were  made  and  income  and  loss  were calculated on  accrual basis.  The assessee in the course of its banking  business used  to charge  interest on advances, including  even   those  which  it  considered  doubtful  of recovery and  which the assessee termed as ’sticky advances’ by debiting  the concerned  parties but in stead of carrying the same  to its  ’Profit & Loss Account’, credited the same to a  separate account  called ’Interest  Suspense Account’. According to  the assessee  the principal  amounts of  these advances labelled as ’sticky advances’ had become not bad or irrecoverable, but  extremely doubtful  of recovery.  In its returns the assessee had disclosed such interests separately and claimed  that the sums were not taxable as income of the concerned years. In view of the relevant years involved, the

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question must  be considered  in the light of the provisions of the Income Tax Act, 1961 (hereinafter called the ’Act’).      Before the  Taxing Officers,  the Tribunal and the High Court, the  assessee’s contention  was that having regard to bad and  deteriorating financial  conditions of  the parties concerned as well as history of their accounts, the recovery of even  the  principal  debts  had  become  improbable  and doubtful, thereby  making these  loans or  advances  as  the assessee called  ’sticky’ and,  as such  interest  on  these though debited  to  the  respective  debtors  was  taken  to ’Interest  Suspense   Account’.  This,   according  to   the assessee, became necessary 69 to avoid  showing inflated profits by including hypothetical and  unreal  income  and,  such  income,  according  to  the assessee, was  not his  real income. It was contended by the assessee that  the said  sums namely  the interest on the so called ’sticky’  loans was  not taxable  in its  hands. This contention  was,   however,  rejected   by  the   Income-tax authorities as well as the High Court.           The following were the grounds for such rejection:           (a) The  assessee  was  following  the  mercantile           system of  accounting; such  interest,  therefore,           had accrued  to the  assessee at  the end  of  the           accounting year.           (b) The assessee itself had treated such income as           accrual of  interest by  charging the  same to the           parties concerned by making debit entries in their           respective accounts.      It was pointed out that if any part of these debits had later on  become irrecoverable  in any  year,  the  assessee could have,  in that  year, treated  the same  as  such  and claimed deduction  under  section  36(1)(vii)  of  the  Act. Reliance was placed by the High Court on an earlier decision of the same High Court in the case of Catholic Bank of India (In liquidation)  vs. Commissioner  of  Income-Tax,  Kerala, Ernakulam., [1964]  K.L.T. 653  = [1965] 1 I.T. Journal 355. In that  case in  spite of  the  directions  issued  by  the Reserve Bank  of India  to the  assessee bank  not to  carry interest  of  such  sticky  advances  to  ’Profit  and  Loss Account’ and  also in  spite of  the fact, that the assessee bank in pursuance of these directions omitted their interest from its  ’Profit and Loss Account’, the court took the view that such interest was taxable as income in the hands of the assessee bank  because the  mercantile system  of accounting had been  regularly followed  by the  bank and  that had not been  changed  even  after  receiving  directions  from  the Reserve Bank of India. The Kerala High Court had relied upon certain observations  in the  commentary on  the Income  Tax Act, 1961,  by Kanga,  5th Edn. Vol. I, page 665 wherein the learned author has stated:           "The assessee  cannot escape  liability to  tax by           omitting to  make an entry or making a wrong entry           in the accounts. The date of taxability of income 70           is the  date when the appropriate entries are made           or should  be made  in the  accounts in accordance           with the  method of  accounting regularly employed           by the  assessee.  The  substantive  part  of  the           section makes  it clear  that the  income is to be           computed’  in   according  with   the  method   of           accounting  regularly  employed.’  The  Income-tax           Officer may  include in  the computation of income           an amount  which does  not figure  in the accounts           but the  inclusion of  which is  required  by  the

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         assessee’s method  of accounting;  that is to say,           the Income-tax  officer may without deviating from           the assessee’s  method, make  such adjustments  in           the profit  and loss  account as are necessary for           giving full and true effect to that method itself.           Having adopted a regular method of accounting, the           assessee cannot  be allowed to change it or depart           from it  for a  particular year or for part of the           year or in respect of particular transactions."      The High Court of Kerala was of the view that the facts of the  instant case  out of which these appeals arise being the same  as those in Catholic Bank’s case except that there was a  direction from  the Reserve Bank of India to Catholic Bank, which  is absent  in the  instant case  before us, the same conclusion  must follow.  In the  opinion of  the  High Court, the  presence or  absence of  such direction from the Reserve Bank  was not  determinative of  the question. There was accrual  of income  to the assessee considering the fact that the  assessee had  been following the mercantile method of accounting  which  had  been  regularly  adopted  by  the assessee and  accepted by  the taxing  authorities. The High Court in  that view  of the  matter answered the question in favour of  the revenue.  For  subsequent  years  1968-69  in respect  of   the  same  assessee,  an  identical  view  was reiterated by  the said  High Court  in the  assessment year 1968-69 as  reported in  110 I.T.R.  336. The correctness of this view is under challenge in these appeals before us.      The assessee  indubitably maintained  its  accounts  on mercantile basis  and had regularly adopted it. The assessee claimed that the three sums represented interests on what it called ’sticky’  loans in  its books  of account  but having regard  to  the  deteriorating  financial  position  of  the concerned debtors  and the  history of  these accounts,  the assessee was  of the  view that  in the  relevant years  the advances had become 71 so ’sticky’  that even the recovery of the principal amounts had  become   highly  improbable   and  extremely  doubtful. Therefore, though  the assessee  charged such  interests  by debiting the  concerned parties  (emphasis supplied)  yet it credited the  said amounts  to a  separate account styled as ’Interest Suspense  Account’. This  the assessee  claimed on the theory  that it  was to avoid showing unreal or inflated profits. The  assessee claimed  that it  was not  taxable as real  income  had  not  accrued  to  it.  It  was,  however, disallowed on  the ground  that the  advances had  not  been treated as  irrecoverable or  bad debts  in terms of section 36(1)(vii) of  the Act.  In coming  to the  conclusion  that these  sums   were  taxable,  the  taxing  authorities,  the Tribunal  and  the  High  Court  proceeded  on  well-settled principles pertaining  to the mercantile system and took the view that  such interest  had fallen  due and became legally recoverable in  accordance with  the  system  of  accounting during each of the relevant accounting years.      In support of the assessee’s contention learned counsel contended before  us that  what are chargeable to income-tax in respect  of a  business, are  profits and  gains of  that business actually  resulting from  the transactions  of  the previous  year.   It  was  submitted  that  even  under  the mercantile system  of accounting accrual or "real income" in the commercial  sense only  was chargeable  to tax  and this must accrue  in substance  according to the realities of the situation. It  was  submitted  that  if  regard  is  had  to realities of  the situation as well as the actual commercial principles, it  would be  evident that  in cases  of  banks,

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financial institutions  and money-lenders bulk of the income is usually  earned by  way of  interest and  as  such  there cannot be  any accrual  of  real  income  from  interest  on doubtful advances  or sticky  advances and,  therefore,  the entries made in respect of such accounts in case of all such traders following  the mercantile  system of accounting only reflected hypothetical  income which does not materialise in income. It  was submitted  that, therefore, it was proper to carry  such  interest  to  ’Interest  Suspense  Account’  as carrying the  same to ’Profit and Loss Account’ would amount to showing an unreal and inflated profit and thereby lead to improper and illegal distribution or remittances thereof.      Therefore, the  question, is,  whether on the theory of real income,  interests which  had  accrued  legally  to  an assessee -  in this  case banking  institution following the mercantile system  of accountancy can be kept out of the net of 72 taxation. How  far does  the concept  of real  income defeat accrual of  income in  any particular  case according to the well-recognised theory  of accounting  principles which  are accepted by the legal standards so far followed?      In this  country, by  and large, two systems of account keeping are  followed -  one is  the  cash  and  the  other, mercantile. Plainly  speaking, the  cash  system  postulates actual receipt  of money; and for exigibility of income tax, such receipt  from business,  profession or vocation or from other sources  has to  be actual  in the  relevant  year  of account. The  mercantile system,  on the  other hand, is one where accounts are maintained on the basis of entitlement of credit and/or  debit. A  sum of money, as soon as it becomes payable, is  taken into  account without reference to actual receipt and a debit becomes admissible when liability to pay is created even though the sum of money is yet to be paid.      Several circulars  issued by the Central Board of Taxes were placed before us in course of the hearing. One such was C.B.R. Circular No. 37/54 dated 25th August, 1924. There the Central Board  had said  that  it  accepted  the  conclusion reached at  the Conference  of Income-tax Commissioners held in August, 1924 that if a money-lender who kept his accounts on the  commercial system  maintained a  suspense account in which he  entered loans  which in his opinion were extremely unlikely to  be recoverable  though  he  did  not  yet  wish actually to  write them off, interest accruing on such loans need not  be included  in the  assessee’s taxable income, if the Income-tax  officer was  satisfied that there was little provability of  recovery of  the loan. This was obviously on the footing  that the  last ray  of hope of recovery had not been extinguished  and the stage for write off had not come. The second circular is one dated 6th October, 1952, which is Circular No.  41(V-6)D of  1952 dealing  with the subject of bad  and  doubtful  debts  -  irrecoverable  loans  or  bank interest on  such debts.  It was indicated therein that when there was  unlikelihood of  loans being recovered, interests from such  loans need  not be included in the taxable income if the  Income-tax Officer  was  satisfied  that  there  was really little  possibility of the loans being repaid. But an account was  to be  maintained  for  future  allowances  for taxation of recoveries in subsequent assessment years. There is also  a letter  dated 16th  April, 1973,  from the  Under Secretary, Central  Board of  Direct Taxes referring to D.O. letter dated 15th March, 1973 reiterating that the 73 amounts kept  in suspense  account under those circumstances would not be taxable. The assessee was, however, required to

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maintain a  systematic method  of accounting  in respect  of dobutful debts  subject to checks and counter-checks. By the letter dated  21st November, 1973, the Reserve Bank of India wrote that  there was no uniformity in the practice followed by State  Financial Corporations  on sticky  loans were  the same position  was reiterated.  A letter was written on 20th June, 1978,  by the  Central Board  of Direct  Taxes to  the Commissioner of  Income-tax soon after the decision rendered in the  assessee’s  case  in  110  I.T.R.  336  referred  to hereinbefore. In  that letter  reference  was  made  to  the previous circulars  and it  was pointed  out that  the stand taken in  these circulars  was not acceptable to the Revenue Audit Department  and it  had objected  to the  exclusion of such amounts  of interest  from the  total income. The Board advised that  where accounts  were kept on mercantile basis, interest was  taxable irrespective  of whether  the same was credited  to   suspense  account  or  to  interest  account. Reference was  made to the decision of the Kerala High Court in 110  I.T.R. 336  which has  been followed  in the instant case. The  Central  Board,  therefore,  directed  that  such interests should  be includible  in the  taxable income, and all pending  cases should be disposed of keeping the present instructions in view. It was further directed that immediate review should  be undertaken under section 147(b) or section 263 of  the Act  in respect  of assessments  which had  been completed in accordance with the Board’s earlier directions. In the  last letter, the same position was reiterated but it was further  clarified as  to future  course of  action.  In these appeals we are not concerned with the actual effect of these Circulars and these need not be set out and examined.      Several financial  institutions sought  to intervene as the question  involved herein is of some importance to them. We have  allowed them  to make  their submissions  and taken them into  consideration. It was urged that the instructions contained in these circulars noted before were in consonance with  the  accepted  principles  of  accountancy  and  these instructions have  held the  field for over 53 years. It was also submitted  that as  such claims have been allowed to be exempted for  more than half a century, and the practice had transformed itself  into law,  this position should not have been deviated  from. This  submission, of  course, cannot be accepted. The question of how far the concept or real income enters into  the question  of taxability  in the  facts  and circumstances of this 74 case and  how far  and to  what extent  the concept  of real income should  inter-mingle with  the accrual of income will have to be judged in the light of the provisions of the Act, the principles  of accountancy  recognised and  followed and the feasibility.  The earlier  circulars being  executive in character cannot alter the provisions of the Act. These were in  the   nature  of   concessions  and   could  always   be prospectively withdrawn.  However, on  what lines the rights of the parties should be adjusted in consonance with justice inview of  these circulars  is not  a subject  matter to  be adjudicated by  us and  as rightly  contended by counsel for the revenue, the circulars cannot detract from the Act.      The profits  and gains  chargeable to tax under the Act are those which have been either received by the assessee or have accrued  to the  assessee during the period between the first and  the last  day of  the year  of  account  and  are receivable. Income  received  or  income  accrued  are  both chargeable  to   tax  under  section  28  of  the  Act.  The computation of  this income is provided for in section 29 of the Act. While we are on the sections, it may be appropriate

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to refer  to section  36 also.  Section 36(a)  provides  for certain deductions  from the  computation of income and sub- section (vii) thereof deals with bad debts in these terms:           "(vii) subject  to the  provisions of  sub-section           (2), the  amount of  any debt,  or  part  thereof,           which is  established to have become a bad debt in           the previous year." Section 36(2)  prescribes the conditions to be satisfied for earning deduction  for a  bad debt.  There is  no dispute in these appeals that such conditions are not satisfied.      Section 56  of the  Act deals  with income  from  other sources and  section 57 deals with deductions in computation of income  from other  sources. Section  145 deals  with the method of  accounting. Sub-section  (1) of  the said section provides that  income chargeable under the head "Profits and gains of  business or  profession"  or  "Income  from  other sources" shall  be computed in accordance with the method of accounting regularly  employed by  the assessee. The proviso in certain  eventualities permits  the Income-tax Officer to adopt the mode for computation of income. Similar too is the position of sub-section (2). 75      It is settled that the income of the assessee will have to be  determined according  to the provisions of the Act in consonance with the method of accountancy regularly employed by the assessee. The method of accounting regularly employed by the  assessee helps  computation of  income, profits  and gains under section 28 of the Act and the taxability of that income under  the Act  will then  have to be determined. The question, is,  whether the  income which  has been  computed according to  the method of accounting followed regularly by an assessee  can be diminuted or diminished by any notion of real income. This has to be judged in the light of the well- settled principles.      In Commissioner  of Income-tax,  Madras, v.  K.R.M.T.T. Thiagaraja Chetty  & Company,  24 I.T.R.  525, this Court as early as  1953 reiterated  that once the sum of Rs. 2,26,850 in that  case was  arrived at  as income that had accrued to the assessee, it did not cease to be the income by reason of the fact  that it  was carried  to the suspense account by a resolution of  the directors  and that  it  was,  therefore, assessable to  tax. The assessee firm therein was a managing agent of  a  limited  company.  Under  the  managing  agency agreement the  assessee was  entitlted to  a certain monthly remuneration -  a commission  of ten  per cent  on  the  net profits of  the company  and a small percentage on sales and purchases. The  agreement further provided that the assessee was at  liberty to  retain, reimburse and pay themselves out of the  funds of  the Company  all moneys  expended  on  its behalf and all sums due to them for commission or otherwise. During the  year of  account ending  31st March,  1942,  the assessee  had   become  entitled  to  a  commission  of  Rs. 2,26,850. On  30th March,  1942, the  assessee wrote  to the company requesting  that a  certain debt, which the assessee owed to  the company  for along time past, should be written off. The  directors by  their resolution, passed on the same debt, refused to write off the amount without consulting the general body  of shareholders  and pending the settlement of the dispute  resolved to  keep the  sum of  Rs. 2,26,850 was debited as  a revenue  expenditure of  the company  and  was allowed as deduction in computing the profits of the company for the  purpose of  income-tax. The question was whether in the assessment  year 1942-43, the assessee was liable to pay tax on  the sum  of Rs. 2,26,850. The Tribunal held that the assessee was being assessed on cash basis in previous years,

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that the income had not accrued to the assessee and that the sum of  Rs. 2,26,850 should be excluded from taxation as not having been  received in the accounting year. The High Court came to 76 the conclusion that there was no material for the Tribunal’s finding that  the assessee  was being assessed on cash basis in the  previous years  but  held  (Satyanarayana  Rao,  J., confirming  the   decision  of   the   Appellate   Tribunal; Viswanatha Sastri,  J., contra) that the sum of Rs. 2,26,850 was not  liable to tax, inasmuch as it was not income of the assessee which had accrued or arisen in the accounting year. This Court  in appeal  held that the High Court was right in its conclusion that there was no material for the Tribunal’s finding that  the assessee  was being assessed on cash basis on the  sums mentioned which had accrued to the assessee and it did  not cease  to be  income. In  this connection,  this Court at page 531 of the Report referred to the observations of Viswanatha  Sastri, J.  wherein  the  learned  judge  had stated: "The  sum had  irrevocably entered the debit side of the company’s  account as  a disbursement of managing agency commission to  the firm  and had  been appropriated  to  the firm’s dues  and same  could  not  again  be  entered  in  a suspence account  at  a  later  date.  The  sum,  therefore, belonged  to  the  firm  and  had  to  be  included  in  the computation of  the profits and gains that had accrued to it unless the  firm had  regularly kept  its accounts on a cash basis, which is not the case here."      This problem  may be better looked into if the question of difference  between the mercantile system and cash system is examined in a little detail.      Sir Courtney  Terrel, C.J.  delivering the  judgment of the Patna  High Court  in Dhakeshwar  Prasad Narain Singh v. Commissioner of  Income Tax,  Bihar & Orissa, 4 I.T.R. 71 at 74.,  noted  the  difference  between  the  two  methods  of accounting for  income, profits  and gains  of business. The learned Chief Justice observed at page 74 of the report:           "Now, there  are two methods of accounting for the           income, profits  and gains of a business which are           generally referred  to as  the cash  basis and the           mercantitle  basis.  According  to  the  former  a           record  is,  as  in  this  case,  kept  of  actual           receipts and  actual payments,  entries being made           only when money is actually collected or disbursed           and if  the profits  of the business are accounted           for  in  this  way  the  tax  is  payable  on  the           difference   between    the   receipts   and   the           disbursements for  the period  in question.  There           is, secondly, the mercantile 77           system under  which a  profit and  loss account is           maintained. At  the end  of the financial year the           assets and  liabilities are  valued and entered in           the account  and the difference between the two is           the profit upon which the tax is paid."      The Commissioner  of Income  Tax, Bombay  v.  Sarangpur Cotton Manufacturing Co. Ltd., 6 I.T.R. 36. Lord Thankerton, speaking for  the  Judicial  Committee  after  referring  to section 13  of 1922  Act which  was more  or less similar to section 145  of the  present Act  observed  at  page  40  as follows:           "Their Lordships  are clearly  of opinion that the           section  relates   to  a   method  of   accounting           regularly employed  by the  assessee for  his  own           purposes -  in this  case for  the purposes of the

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         Company’s business  - and  does not  relate  to  a           method  of  making  up  the  statutory  return  of           assessment to  income-tax. Secondly,  the  section           clearly  makes   sucha  method   of  accounting  a           compulsory basis  of  computation  unless  in  the           opinion of  the Income-tax  Officer,  the  income,           profits  and  gains  cannot  properly  be  deduced           therefrom. It  may well be that, though the profit           brought out in the accounts is not the true figure           for income-tax  purposes the  true figure  can  be           accurately deduced  therefrom. The  simplest  case           would be  where it  appears on  the  face  of  the           accounts that a stated deduction has been made for           the purpose  of a  reserve. But  there may will be           more complicated  cases in  which nevertheless, it           is possible  to deduce  the true  profits from the           accounts,  and  the  judgment  of  the  Income-tax           Officer  under   the  proviso   must  be  properly           exercised. It  is misleading  to describe the duty           of  the  Income-tax  Officer  as  a  discretionary           power."      Iqbal Ahmad,  C.J. has  aptly described in Commissioner of Income  Tax v.  Shrimati Singari  Bai, 13 I.T.R. 224, the mercantile system  of accountancy  and has  observed at page 227 of the report as follows:           "The distinguishing  feature  of  this  method  of           accountancy is  that it brings into credit what is           due immediately  it becomes legally due and before           it is actually received; and it brings into debit 78           expenditure the amount for which a legal liability           has been incurred before it is actually disbursed.           The  ’mercantile   accountancy  system’   is   the           opposite of  the ’cash  system’  of  book-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."      In   Commissioner   of   Income-Tax,   Madras   v.   A. Krishnaswami Mudaliar  and Others, 53 I.T.R. 122, this Court had to  refer to  the distinction  between mercantile system and cash system. Referring, however, to the relevant section appropriate to  section 145  of the  present Act, this Court observed that  the section  did not  compel  the  Income-tax Officer to  accept a  balance-sheet  of  cash  receipts  and outgoings prepared from the books of account: it was for him to compute  the income  in accordance  with  the  method  of accounting regularly  employed by the assessee. Referring to the prevalent  system of  book-keeping in  India,  Shah,  J. speaking for  this Court  observed at  pages 129-130  of the report as follows:           "Among Indian businessmen, as elsewhere, there are           current two  principal  systems  of  book-keeping.           There is,  firstly, the  cash system  in  which  a           record is  maintained of actual receipt and actual           disbursements, entries  being posted when money or           money’s worth  is actually  received, collected to           disbursed.  There  is,  secondly,  the  mercantile           system, in  which entries  are posted in the books           of account  on the  date of  transaction, i.e., on           the date on which rights accrue or liabilities are           incurred, irrespective of the date of payment. For           example, when  goods are sold on credit, a receipt           entry is  posted as  of the date of sale, although           no cash is received immediately in payment of such

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         goods; and  a debit entry is similarly posted when           a  liability   is  incurred  although  payment  on           account of such liability is not made at the time.           There may  have to  be appropriate variations when           this system  is adopted by an assessee who carries           on a  profession. Whereas under the cash system no           account of what are called the outstandings of the           business either  at the  commencement  or  at  the           close of  the year  is  taken,  according  to  the           mercantile method  actual cash receipts during the           year and the 79           actual cash outlays during the year are treated in           the same  way as under the cash system, but to the           balance thus arising, there is added the amount of           outstandings not  collected at the end of the year           and from this is deducted the liabilities incurred           or accrued  but not  discharged at  the end of the           year. Both the methods are somewhat rough. In some           cases these  methods may  not give a clear picture           of the  true profits  earned and  certainly not of           taxable  profits.   The  quantum   of   allowances           permitted to be deducted under diverse heads under           section 10(2)  from the  income, profits and gains           of a business would differ according to the system           adopted. This  is made  clear by  defining in sub-           section (5)  the word  "paid"  which  is  used  in           several clauses  of  sub-section  (2)  as  meaning           actually paid  or incurred according to the method           of accounting  upon the basis of which the profits           or gains  are computed  under  section  10.  Again           where the  cash system  is adopted,  there  is  no           question of  bad debts  or outstanding  at all, in           the case  of mercantile  system against  the  book           profits some  of the  bad debts may have to be set           of  when  they  are  found  to  be  irrecoverable.           Besides the cash system and the mercantile system,           there are  innumerable other systems of accounting           which may  be called  hybrid or heterogeneous - in           which certain  elements and  incidents of the cash           and mercantile systems are combined."      For the content of the taxable income, one has to refer to the  substantive provisions  of the Act, mainly section 5 of the Act read with other relevant sections.      In Commissioner of Income-Tax, Bombay City I v. Messrs. Shoorji Vallabhdas  and  Co.,  46  I.T.R.  144,  this  Court discussed the  concept of  real income.  There the  relevant fact was  that before  the close  of the relevant accounting year which  was from 1st April, 1947 to 31st December, 1947, in November,  1947 the  assessee had  desired  to  have  the managing agency  transferred to  two private  companies  and this was  transferred by  a subsequent  agreement after  the close of  the year.  The  assessee  in  that  case  in  fact received only  the lesser  amount in spite of the entries in the account  books, and  it was held that this lesser amount alone was taxable. It 80 was reiterated  by Hidayatullah  J.  as  the  learned  Chief Justice then  was, that  income-tax is  a levy on income and the Income-tax  Act took  into account two points of time at which the  liability to  tax was attracted viz., the accrual of the  income or  its receipt;  yet the  substance  of  the matter was  income. If  income did  not result at all, there could not  be any tax, even though in book-keeping, an entry was  made  about  a  "hypothetical  income"  which  did  not

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materialise. Where income has, in fact, been received and is subsequently given up, in such circumstances that it remains the income  of the  recipient, even though given up, the tax might be payable. Where, however, the income can be said not to have resulted at all, there was obviously neither accural nor receipt  of income,  even though an entry to that effect might, in certain circumstances, have been made in the books of account. This decision and the use of the expression that entry of the ’hypothetical income’ is often misunderstood in the sense  that after  the accrual  if the  income  did  not materialise then on the basis of the actuality or reality of the situation  it should  not be  considered to be income at all. But  the significant  fact which is often lost sight of is that  within the relevant accounting year viz. 1st April, 1947 and 31st December, 1947, in November, 1947 the assessee had desired  to have  the managing agency transferred to two private  companies  and  the  subsequent  agreement  in  the following year viz. December, 1948 was merely fructification or carrying  into effect  of that  desire and as a result of the same, the income did not accrue. That this was the basis for the  ratio of  the decision of this Court would be clear because this Court referred to and relied on the decision of the Bombay  High Court in Commissioner of Income-tax, Bombay North,  Kutch   and  Saurashtra,   Ahmedabad  v.   Chamanlal Mangaldas &  Co., 29  I.T.R. 987  in this  respect. That was also a  case of  managing agency  company’s  entitlement  to receive commission  at a certain rate. By another agreement, in the  case of  commission earned by the managing agent for the calender  year 1950  was reduced  to Rs.  1  lakh.  That agreement i.e.  the subsequent  agreement took  place during the previous  year, and  the resolution  of the board of the director of  the managed  company was  also in  the previous year but  it was, however, made final on 8th April, 1951, at a meeting of the board of directors but at a time beyond the previous year.  The High  Court had  taken the  view that by reason of the resolution during the currency of the previous year, the  right of  the assessee to commission ceased to be under the  original agreement  and dependent  upon and arose only after the decision of 81 the  board  of  directors  to  reduce  the  commission.  The assessee was,  therefore, held  not liable on the larger sum as it  was only  a hypothetical  income which  it might have earned if  the old agreement had subsisted. This Court found that the  facts of  that case were almost identical with the facts  in   Shoorji  Vallabdas’s   case.  Therefore  Shoorji Vallabhdas’s case  must be  understood on  the footing  that because of  the desire in November, 1947, the commission did not accrue  at the end of the accounting year. In that sense there was  no accrual  of the  income. It  may be reiterated that in  some limited  fields where  something which  is the reality of the situation prevents the accrual of the income, then the notion of real income i.e. making the income accrue in the  real sense  of the term can be brought into play but the notion of real income as it shall presently be indicated cannot be  brought  into  play,  where  income  has  accrued according to  the accounts  of the  assessee and there is no indication by the assessee to treat the amount as not having accrued. Suspended  animation  following  inclusion  of  the amount in  the suspense  account does not negate accrual and after the  event of  accrual,  corroborated  by  appropriate entry in the books of account, on the mere ipse dixit of the assessee, no reversal of the situation can be brought about.      Morvi Industries  Ltd. v.  Commissioner  of  Income-Tax (Central), Calcutta,  82 I.T.R.,  835., was  also a  case of

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giving up  the commission  which had  accrued though in that case the  payment had  been deferred till after the accounts had been passed in the meetings of the managed company. This Court held  that such a situation did not affect the accrual of the  income. This  Court found that the amounts of income for the  relevant years  were given  up unilaterally  by the assessee after  these had  accrued and  it could  not escape liability to  tax on  those amounts.  This Court  reiterated that income  accrued when it became due. The postponement of the date  of payment  did not  affect the accrual of income. The fact  that the amount of the income was not subsequently received by  the assessee  would not  also detract  from  or affect the accrual of the income although non-receipt may in appropriate cases  be a valid ground for claiming deduction. This  Court   reiterated  that   the  mercantile  system  of accounting differed  substantially from  the cash  system of book-keeping. Under the cash system, it was only actual cash receipts and  actual cash  payments that  were  recorded  as credits and  debits; whereas,  under the  mercantile system, credit  entries   were  made   in  respect  of  amounts  due immediately they became legally payable 82 and before  they  were  actually  received.  Similarly,  the expenditure  items   for  which  legal  liability  had  been incurred were immediately debited even before the amounts in question  were   actually  disbursed.   This  position   was reiterated  by   this  Court   in  1971  after  taking  into consideration various  decisions of this Court. In our view, therefore, the  concept of  real income cannot be so used as to make  accrued income  non-income simply because after the event of  accrual, the  assessee neither decides to treat it as bad debt nor claims deductions under section 36(2) of the Act, but  still enters  the same  with a  diminished hope of recovery in  the suspense  account. Extension of the concept of real  income to  this field  to negate  accrual after the amount had  become payable  is contrary to the postulates of the Act.      It may  be mentioned  that before  the decision  of the Bombay High  Court in H.M. Kashiparekh & Co. Ltd.’s case, 39 I.T.R. 706., rendered on 1st and 2nd April, 1960, a decision having relevance  on the  concept of  real income  and about whose important  facts we  shall advert later, this Court in February, 1960 in Commissioner of Income-Tax Bombay North v. Chamanlal Mangaldas  & Co.  (supra) had  to consider some of these  aspects.   In  that  case  there  was  provision  for reduction of  commission where  profits were insufficient in case of  the managing  agent. There  was modification of the commission before  the end of the year. The amount was given up by  the managing  agent.  The  question  that  arose  was whether the  income had  accrued and  what was the effect of the entries  made in  the books  of account.  It was held by this  Court   that  the  agreement  was  an  integrated  and indivisible one and the managing agent’s commission was only determinable and  accrued when  the year  was over.  It  was further held  that the  fact that  the amounts of commission were credited  in the books of the managed company every six months  only  meant  that  as  an  interim  arrangement  the accounts of  all sales were made up at the end of six months also. But this did not affect the construction of the clause containing the  terms for  payment  of  commission  nor  the deduction  made   therein  as   a  result  of  the  modified arrangement. The amount which arose or accrued and which the managing agent  had the right to receive was not affected by the manner  in which  the entry was made. The managing agent was entitled  to receive  as commission  only a  sum of  Rs.

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4,11,875 and  that amount  alone  accrued  to  the  managing agent. This  Court reiterated  the principle that the amount which would 83 arise or accrue to the managing agent and the managing agent would have  a right  to receive would not be affected by the manner in  which entry  was made. The existence of the right to receive  i.e. accrual,  is important and that is a matter of the  reality of  the  situation  keeping  the  terms  and conditions and  the conduct of the parties. In Kashiparekh’s case (supra),  the Division  Bench of  the Bombay High Court dealt with an assessee firm which had maintained its account in the  mercantile system.  The assessee  was  the  managing agent of  a paper  mill company.  Under the  managing agency agreement, it  was under  a duty  to forgo upto one-third of its commission  when the profits of the managed company were not sufficient  to pay  the dividend  of 6 per cent. For the accounting year  ending on 31st December, 1950, the assessee had earned  a commission  of Rs. 1,17,644 but as a result of the resolutions  passed  by  the  managed  company  and  the assessee company the assessee gave up a sum of Rs. 97,000 in December, 1950. The Appellate Tribunal held that the maximum amount the  assessee was  bound to forgo was only Rs. 39,215 and included  the balance  of amount forgone viz. Rs. 57,785 in the taxable income. The Tribunal, however, found that the sum  of  Rs.  57,785  was  also  given  up  for  reasons  of commercial expediency. The Division Bench of the Bombay High Court held  that it  was the  real income  of  the  assessee company for  the accounting  year that was liable to tax and that the  real income could not be arrived at without taxing into the  account the  amount forgone  by the  assessee.  In ascertaining the  real income  the fact  that  the  assessee followed the  mercantile system  of accounting  did not have any bearing.  The accrual  of the  commission, the making of the accounts,  the legal  obligation to  give up part of the commission and the forgoing of the commission at the time of the making  of the accounts were not disjointed facts: there was a  dovetailing about  them which  could not  be  ignored (emphasis supplied). The real income of the assessee, it was further held,  was Rs.27,644  and the  amount of  Rs. 97,000 forgone by  the assessee  could not  be included as the real income of  the assessee  for the  accounting year.  The  two rules that  income-tax is  annual  in  its  structure,  and, therefore, the computation for each year is a distinct self- contained unit  and the other that the income to be taxed is the real  income of  the assessee  are not  incompatible  or irreconcilable; they  admit of  harmonious application.  The principle of  real income  is not  to be  so subordinated to virtually amount  to a  negation of  it when  a surrender or concession  or   rebate  in   respect  of   managing  agency commission is made, agreed to or given on grounds of 84 commercial expediency,  simply because  it takes  place some time after the close of an accounting year. In examining any transaction and  situation of  this nature,  the court would have more  regard to  the  reality  and  speciality  of  the situation rather than the purely theoretical and doctrinaire aspect of  it. It laid great emphasis on the business aspect of the  matter viewed  as a  whole when  that could  be done without disregarding  the language of the statute. It may be pointed out  that the decision in Kashiparekh’s case (supra) has received  approval of  this  Court  in  Commissioner  of Income-Tax, West  Bengal II  v. Birla  Gwalior (P)  Ltd., 89 I.T.R. 266., but in our opinion it is necessary to reiterate the real  facts and  the basic  principles of  Kashiparekh’s

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case. It  is true  that the concept of real income will have its effect  also in  mercantile system  of accounting. There the accounting  year was  ending 31st  March, 1950.  For the account year  31st  March,  1950  the  assessee  had  earned commission but  as  a  result  of  resolutions  passed,  the assessee company gave up Rs. 97,000 in December, 1950.      The  question   involved,  was,   whether  the  accrued interest  in   the  accounting   year  could   be  given  up subsequently  or   not.  Now   looked  at  from  the  proper perspective, the  Court was of the view, as we read it, that the right  to the commission arose under the managing agency agreement. Under  the agreement  there was  a duty  to forgo upto one-third of the commission where profit of the managed company was  not sufficient to pay a divident of 6 per cent. It is  in the peculiar situation arising out of the managing agency agreement  that subsequently  a sum of Rs. 97,000 was given up  in December,  1950. In  this context  the fact  of surrender and  the concept of real income must be viewed. It was really  to implement  the obligation  under the managing agency agreement  that the  giving up took place. Therefore, the accrual  of commission,  the making of the accounts, the legal obligation  to give  up part of the commission and the forgoing of  the commission at the time of the making of the accounts were  considered not  to be disjointed facts. There was  dovetailing   about  these  which  in  reality  of  the situation could  not be  ignored. This  is not  a case where there being  no previous  obligation after  interest  having been earned  in the sense of having accrued according to the mercantile system  of accounting,  the  assessee  after  the close of  the accounting year without giving up the interest which the  assessee could  have as a bad debt, did not offer it  for  taxation  but  carried  it  to  ’interest  suspense account’. 85 Carrying  certain  amount  which  had  accrued  as  interest without treating  it as  bad debt  or irrecoverable interest but keeping  in  suspense  account  would  be  repugnant  to section 36(1)(vii)  read with  section 36(2) of the Act. The concept of  real income must not be so read as to defeat the object and the provision of the statutory enactment. In that view of  the matter  Kashiparekh’s case  would not be of any assistance to  the assessee for the contentions it sought to urge before this Court in the instant case.      As mentioned  hereinbefore this  Court in Birla Gwalior (P) Ltd.’s  case (supra)  had dealt with Kashiparekh’s case. That decision  before the  court  was  an  appeal  from  the decision of the Calcutta High Court (78 I.T.R. 788) in which delivered the  judgment. It  was felt by the High Court that reading the  order of the Tribunal as a whole though various contentions were  raised before  the Tribunal,  the Tribunal had mainly  decided the question applying the theory of real income and  held that  these amounts  did not  form the real income of  the  assessee,  inasmuch  as,  according  to  the Tribunal, the  remunerations  were  forgone  on  grounds  of commercial expediency.  The High Court held that once it was decided that  these amounts  did not  form part  of the real income of the assessee which was liable to tax, the question of deduction  under section 10(2)(xv) of the 1922 Act became irrelevant. There  the question  really  was  when  did  the income really  accrue - whether at the end of the accounting year or  upon the  making up of the accounts, in case of the entitlement of  commission of  the assessee  in the managing agency commission  and office allowance. This Court (at page 270 of  89 I.T.R.)  noted that  the date  for payment of the commission was  stipulated in the managing agency agreement.

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The accounting  year of  the assessee as well as the managed companies was the financial year. The respondent gave up the managing agency  commission from both the managed companies, for the  assessment years  1954-55 to 1956-57, after the end of the relevant financial years but before the accounts were made up by the managed companies. This Court emphasised that as the managing agency commission receivable could have been ascertained only  after the  managed company had made up its accounts and  the assessee  had given up the commission even before the managed company made up its accounts, and no date had been  fixed in  the agreement  for the  payment  of  the commission,  the   mere  fact   that  the   respondent   was maintaining its  accounts on  the mercantile  system did not lead to the conclusion that the 86 commission had  accrued to  it by  the end  of the  relevant accounting year.  The commission  given up by the respondent could not  be considered  to be its real income. It is clear that the  fact of  the case  was that  the  managing  agency commission  receivable  by  the  assessee  could  have  been ascertained only  after the  managed company had made up its accounts and  as it  had  not  made  up  its  accounts,  the commission did  not  accrue  to  the  assessee  company  and therefore the  giving up which was for valid reasons was not given up after the accrual of income.      Dealing with  Kashiparekh’s case  this  Court  observed that an  argument was advanced before this Court that as the assessee was  maintaining its  accounts on mercantile basis, the commission  had accrued.  This contention  did not  find favour with this Court, because this Court noted that no due date was  fixed for  payment of  the  commission  under  the managing  agency   agreement.  Therefore,   whether   in   a particular case  managing agency  commission had  accrued or not would  depend  upon  various  factors  and  there  is  a dovetailing of  these factors. It is in this light that this Court  understood   Kashiparekh’s  case  and  approved  that decision at  page 270  of the  report. In  my opinion,  this approval by  this Court  on this  basis does  not  help  the assessee in  the present  appeals before  us. It  has to  be pointed out  that  the  facts  in  Kashiparekh’s  case  were peculiar and  the court  wanted to relieve the assessee from the undue  hardship of  tax liability.  The ratio  of a case with such  special features may not be available for general application.      The Bombay  High Court  in Commissioner  of Income-tax, Bombay I  v. Confinance Ltd., 89 I.T.R. 292, held that under the income-tax  law receipt  of  income,  either  actual  or deemed, is  not a  condition precedent  to taxability. These were assessable  if these had arisen or accrued or deemed to have accrued  or arisen  under the Act. This principle would be attracted  even in  cases where  an assessee followed the mercantile system  of accounting.  However, in examining any transaction or  situation, the  Court would have more regard to  the   reality  of   thesituation  rather   than   purely theoretical or  doctrinaire aspect. It was held in that case after discussing  the  facts  that  there  were  hardly  any receipts in  respect of  items of  interest or that the bona fides of  the assessee  in not  charging interest  were  not disputed,  were   circumstances  which  were  by  themselves insufficient to support the conclusion that 87 there was no real income in respect of the items of interest as none  of the debts due by the several debtors was written off by  the assessee  and no  evidence was  produced to show that interest in respect of the debts was given up. The High

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Court, therefore, held that there was no giving up and these incomes were  assessable. I  am in respectful agreement with the conclusion of the Bombay High Court. In the instant case before us  the facts  are still  worse. The assessee has not only not  written off,  but it  is still  treating loans  as alive by keeping them in suspense account. Kantawala, J., as the Chief  Justice then  was, followed the correct principle therein after  considering Kashiparekh’s  case (supra).  The principles enunciated  therein are  in consonance  with  the decision of the Calcutta High Court in James Finlay & Co. v. Commissioner of Income Tax., 137 I.T.R. 698, where all these relevant authorities including Kashiparekh’s case as well as Birla Gwalior  (P)  Ltd.’s  case  have  been  discussed  and analysed. In  that case the accounts of the assessee company for the  year 1970-71 included an amount of 8,264 from B & G and Rs.  55,920 from  S.P. Ltd.  receivable as interest. The interest due  from B  & G  were on advances made in 1966 and that from  S.P. Ltd.  were on  advances made  in  1965.  The assessee was  following the  mercantile system of accounting and  the  Income-tax  Officer  treated  both  the  items  of interest as  the assessee’s income for 1970-71. The assessee used to  credit the interest to its profit and loss account. It urged  that it  had decided to change w.e.f. 1st January, 1968, its  method of accounting in respect of interest which was doubtful  of recovery, and that such interest was thence forward credited  to the suspense account. The Tribunal held that there  was no  change in  the method  of accounting and that before  the closing  of the  books of  account  of  the relevant accounting year, the assessee had not abandoned its claim of interest and as such the amounts were assessable on accrual basis.  On a  referene, the High Court held that the alteration of  practice  in  book-keeping  and  transfer  of amounts to  the suspense  account could  not be  termed as a change in  the method  of accounting. In the instant appeals before us,  the position  is still  worse for  the assessee. There is no claim that there was any change in the method of accounting. The  High Court  further held  in James Finlay’s case that  though there  was  difficulty  in  realising  the interests in  the year  of account, there was no material to show that  there was any agreement with the debtors to waive the interest  or to  keep these  in suspense account. Hence, the claim  for interest  had not  been given up. The amounts accrued 88 and continued  to remain  accrued and  were therefore income assessable to tax.      Our attention  was drawn  to certain  passages in  some recognised text  books on accountancy. Reference was made to "Advanced Accounts"  by Shukla and Grewal (Ninth Revised and Enlarged Edition  1981) as  well as  to Spicer  and Pegler’s "Practical Auditing"  by W.W. Bigg (Fourth Indian Edition by S.V. Ghatalia)  where it  has been  suggested that  doubtful debts  might   be  carried  to  interest  suspense  account. Reference  was  also  made  to  the  Approved  Text  of  the "International Accounting  Standard 18".  Relevant  passages from these  books have  been set  out in the judgment of our learned brother  Tulzapurkar, J.  No useful  purpose will be served by  repeating these. Even if in a given circumstance, the amounts  may be treated as interest suspense account for accountancy purpose  that would  not affect  the question of taxability as  such. This must be determined by well-settled legal principles  and principles  of accountancy  which have been referred to hereinbefore.      The concept  of reality of the income and the actuality of the situation are relevant factors which go to the making

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up of the accrual of income but once accrual takes place and income accrues, the same cannot be defeated by any theory of real income.  Reference may  be made to Calcutta Co. Ltd. v. Commissioner of Income-Tax, West Bengal, 37 I.T.R. 1.      Three decisions,  two of  the Madras High Court and one of the  Punjab and Haryana High Court, which shall presently be noticed,  were pressed  into service  on  behalf  of  the assessee to  suggest that  the concept of real income can be so applied  as to  make, where the chances of realisation of accrued income are less it non est.      In Commissioner  of Income-tax,  Tamil Nadu-V  v. Motor Credit Co.  Pvt. Ltd.,  127  I.T.R.  572,  the  assessee,  a private company,  was carrying  on business as financier for purchase of  motor vehicles  on hire  purchase. It  advanced under hire  purchase agreements  monies to  two firms  which were plying buses. The routes of these two firms having been taken  over  by  a  State  Transport  Corporation  following nationalisation, the  firms defaulted  in making  payment of the hire  purchase instalments,  and consequently  the buses were seized.  As the assessee-company was advised that there was no prospect of recovering even the principal amount, the assessee-company did 89 not credit  the interest  on the  outstandings from  the two companies even  though it was adopting the mercantile system of accounting.  The Income-tax  Officer, however, included a sum of  Rs. 56,163 by way of accrued interest on the amounts outstanding against  these  two  firms.  There  in  fact  no interest accrued in view of the facts because there was hire purchase and  the State transport corporation had taken over the firms.  Therefore, there  was no  question of paying any hiring charges  or interest.  In that view it was considered to be  unrealistic that  income accrued. If the actuality of situation or  the reality of a particular situation makes an income not  to accrue,  then very  different  considerations would apply. But where interest has accrued and the assessee has debited  the account of the debtor the difficulty of the recovery would not make the accrual non-accrual of interest.      In Commissioner  of Income-Tax,  Madras Central v. Devi Films (P)  Ltd., 143  I.T.R. 386, the Madras High Court held that the regular mode of accounting only determined the mode of computing  the taxable  income and  the point  of time at which  the   tax  liability  was  attracted.  It  would  not determine or affect the range of taxable income or the ambit of taxation.  It was  further held  that where no income had resulted, it  could not  be said  that  income  had  accrued merely on  the ground  that the  assessee had been following the mercantile  system of  accounting. Even  if the assessee made a  credit entry to that effect still no income could be said to have accrued to the assessee according to the Madras High Court.  If no  income had  materialised, it was pointed out, there  could be no liability to tax on any hypothetical accrual  of   income  based  on  the  mercantile  system  of accounting followed by the asessee that had to be taken into account, but  what should  be  considered  was  whether  the income had  really materialised or resulted to the assessee. The question  whether real  income had  materialised to  the assessee had  to be  considered with reference to commercial and business  realities of  the situation.  In that case the assessee company  had entered  into an  agreement with M who was producing a Kannada film. The film was in the process of production and  the producer  wanted finance to complete the picture  and   approached  the   assessee  and  offered  the exclusive distribution  rights of  the  picture  in  certain areas in  Karnataka State.  The assessee agreed to advance a

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sum of  Rs. 2,80,000.  Under the  agreement the  assessee as distributor could  deduct the commission and appropriate the balance 90 towards the discharge of the amount advanced to the producer and  after   the  advance   was  completely   adjusted,  the distributor had  to remit  to the producer the realisactions after deducting  the commission. The distribution commission was to  be calculated  at 35%  of the net realisation on the picture. The  producer undertook to complete and deliver the prints for  the release  of the  picture failing  which  the producer under  took to  pay damages  together with interest for the  amount received  at 12%  per annum from the date of default to  the date  of delivery  of the  prints  and  also provided certain  sum for  certain contingency.  It  is  not necessary to  set out  in detail  the further  facts. It was held that the assessee was in a position to realise only Rs. 3,47,000 approximately during the three years in question as against a  total sum or Rs. 4,37,828 incurred as the cost of production. The  Tribunal was  justified in the High Court’s view that  having regard  to  the  terms  of  the  agreement entered into  between the  parties and  in the  light of the entries contained  in the accounts, the commission could not be said  to have  accrued in  favour  of  the  assessee,  as commission could  be earnt only after the entire advance had been realised.  The decision,  as is apparent from its tenor rested upon the peculiar facts. As the advances could not be realised because  of the contingencies that happened in that case, the commissions did not accrue or could not be said to have actually  accrued. As  mentioned before, the concept of real income  may have  to be given precedence in computation of income  in a particular case but accrued income cannot be waived as not having accrued to the assessee. Sethuraman, J. who  delivered   the  judgment   of  the   bench  noted  the distinction between  the James  Finlay’s case  and the  case before him  in the  Madras  High  Court.  Dealing  with  the Calcutta case,  Sethuraman, J. observed at page 395 that the waiver of interest would be inconsistant with the entries in the books,  since the  interest had  been  credited  to  the suspense account.  As in the instant case before us in these appeals the  learned judges  of the  Madras High  Court also referred to  Morvi Industries  Ltd. (supra)  where affirming the Calcutta  High Court  decision, it  was found  that  the relinquishment by  the assessee of its remuneration after it had become  due was  of no  effect and  that the  amount was liable to  be taxed.  The Madras  High Court  felt that this Court had  considered only  in the  light of  the system  of accounting followed  by the  assessee and  further  observed that this  Court in  the aforesaid  decision  had  not  been referred to  the notion  of real  income. It  is unfortunate that the High 91 Court chose  to side-track  a binding decision of this Court on a wholly untenable ground.      In Commissioner of Income-Tax, Amritsar-II v. Ferozepur Finance (P)  Ltd. 124  I.T.R. 619., the facts were different and the Punjab and Haryana High Court hald that that even in the mercantile system of accountancy an assessee could forgo the whole  or part of a debt, which was irrecoverable. There the court came to the conclusion that there was no income in view of the particular facts and circumstances of the case.      An acceptable formula of co-relating the notion of real income in  conjunction with the method of accounting for the purpose of computation of income for the purpose of taxation is difficult  to evolve. Besides any straight jacket formula

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is bound  to create  problems in  its application  to  every situation. It  must depend  upon the facts and circumstances of each  case. When  and how  does an income accrue and what are the  consequences that follow from accrual of income are wellsettled. The  accrual must  be real  taking into account the actuality  of the  situtation. Whether  an  accrual  has taken place  or not  must in  appropriate cases be judged on the principles  of real  income theory.  After accrual  non- charging of tax on the same because of certain conduct based on the  ipse  dixit  of  a  particular  assessee  cannot  be accepted.  In   determining  the   question  whether  it  is hypothetical income  or whether real income has materialised or not,  various factors will have to be taken into account. It would  be difficult and improper to extend the concept of real income  to all  cases depending  upon the ipse dixit of the assessee  which would then become a value judgment only. What has  really accrued to the assessee has to be found out and what  has accrued  must be  considered from the point of view of  real income taking the probability or improbability of realisation  in a  realistic manner  and  dovetailing  of these factors  together but once the accrual takes place, on the conduct of the parties subsequent to the year of closing an income which has accrued cannot be made "no income".      The extension  of such a value judgment to such a field is a  pregnant with  the possibility of misuse and should be treated with  caution; otherwise  one  would  be  on  sticky grounds. One  should proceed  cautiously and not fall a prey to the shifting sands of time.      As a  result of the aforesaid discussion, the following propositions emerge; 92      (1) It is the income which has really accrued or arisen to the  assessee that  is taxable.  Whether the  income  has really accrued  or arisen  to the assessee must be judged in the light  of the  reality of the situation. (2) The concept of real  income would apply where there has been a surrender of income  which in  theory may  have  accrued  but  in  the reality of  the situation no income had resulted because the income did  not really  accrue. (3)  where a debt has become bad deduction  in compliance  with the provisions of the Act should be claimed and allowed. (4) Where the Act applies the concept of  real income  should not  be so read as to defeat the provisions  of the Act. (5) If there is any diversion of income at  source under  any statute or by over-riding title then there  is no income to the assessee. (6) The conduct of the parties in treating the income in a particular manner is material evidence  of the fact whether income has accrued or not. (7)  Mere improbability  of recovery, where the conduct of  the  assessee  is  unequivocal,  cannot  be  treated  as eivdence of the fact that income has not resulted or accrued to the assessee. After debiting the debtor!s account and not reversing that  entry -  but taking  the interest  merely in suspense account  cannot be  such evidence  to show  that no real income  has accrued  to the assessee or treated as such by the assessee. (8) The concept of real income is certainly applicable in  judging whether  there has been income or not but in  every case  it must  be applied with care and within well-recognised limits.      We were invited to abandon legal fundamentalism. With a problem like  the present one, it is better to adhere to the basic fundamentals  of the  law with clarity and consistency than to  be carried  away by  common cliches. The concept of real income  certainly is  a well-accepted  one and  must be applied in  appropriate cases  but with  circumspection  and must  not  be  called  in  aid  to  defeat  the  fundamental

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principles of law of income-tax as developed.      For the  reasons aforesaid,  with respect,  it  is  not possible for  me to  agree with  the answer  proposed by  my learned brother,  Tulzapurkar, J.  on the first question. In the premises  question number  (1) should be answered in the affirmative and in favour of the revenue and question number (2) must  also, in  respectful  agreement  with  my  learned brother, be answered in the affirmative and in favour of the revenue. The  appeals therefore must fail and are dismissed. But in view of 93 the facts  and circumstances  of these  cases, parties  will bear their own costs throughout.      RANGANATH MISRA, J. I have had the advantage of reading the  two   separate  judgments   by  my   learned   brothren .Tulzapurkar and Mukharji, JJ.      I am  in agreement  with both  of them  that the second question had  been  correctly  answered  in  favour  of  the Revenue by  the  High  Court  and  the  appeals  are  to  be dismissed on  affirmation of  that conclusion so far as that aspect is concerned.      In  regard   to  the  answer  proposed  for  the  first question, I  have bestowed my careful consideration and I am in agreement  with the reasonings and conclusions reached by my learned  Brother Mukharji,  J. I  am  of  the  view  that section 36(2)  of the Income Tax Act covers the entire field regarding deduction  for bad  debt. Though  the  concept  of !real  income!   is  well   recognised  one,  it  cannot  be introduced as  an outlet  of income  from taxman!s  net  for assessment on the plea that though shown in the account book as having  accrued, the  same became  a bad debt and was not earned at  all. It  is well  settled  that  the  citizen  is entitled to  the benefit  of every  ambiguity  in  a  taxing statute  but  where  the  law  is  clear  considerations  of hardship, injustice  or anomaly  do not afford justification for exempting  income from  taxation  (see  Mapp  v.  Oram., [1969] (vol.III) All Eng. Reports 219 (H.L.) The appeals  shall stand  dismissed with  the direction that the  parties   shall  bear   their  own   respective   costs throughout.                            ORDER      In  view   of  the   majority  judgments   appeals  are dismissed. A.P.J. 94