1. Loan advanced by company to firm — Interest waiver via resolution — Dispute over accrual of income under mercantile system of accounting — Income Tax Act. (Para 1 , 2 )
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1996 Supreme(SC) 1577
1996(7) Supreme 490
SUPREME COURT OF INDIA
B.P. Jeevan Reddy & Suhas C. Sen, JJ
Commissioner of Income Tax, Amritsar -Appellant
versus
M/s. Shiv Prakash Janak Raj & Co. Pvt. Ltd. etc. -Respondents
Civil Appeal Nos. 1906-18 of 1979
Decided on 30-9-1996
Counsel for the Parties :
For the Appellant : J. Ramamurthy, Sr. Advocate, B.S. Ahuja, S.N. Terdol, Advocates.
For the Respondents : G.C. Sharma, Sr. Advocate, S. Rajappa and K.B. Rohtagi, Advocates.
Important Points
Under the mercantile system of accounting, income that has accrued is taxable even if subsequently relinquished unilaterally. If the waiver occurs after the accounting year ends, the income is deemed to have accrued, and the 'real income' theory cannot be used to avoid tax liability.
Subject
Income Tax - INCOME ACCRUAL
Act Referred
Headnote
TAXATION-Income Tax Act, 1961-Section-Assessment years 1969-70. 1970-71 and 1971-72-Assessment proceedings -Interest bearing loans-Assessee company relinquished interest without any commercial considerations-Directors / shareholders of assessee-company were interested in the firm-Resolution to waive interest was passed after expiry of accounting year-Assessee-company following mercantile system of accounting-Waiver not based upon any commercial considerations-Interest must be held to have already accrued to assessee before it was waived-Concept of real income cannot be employed so as to defeat provisions of the Act and the Rules. (Paras 5 & 7)
Legal Category Hierarchy
Table of Contents
2. Revenue contends interest accrued upon becoming due regardless of subsequent waiver; Assessee argues no real income accrued as interest was waived and not received. (Para 3 , 4 , 7 )
3. Court analyzed the mercantile system of accounting, distinguishing between waivers occurring before and after the end of the accounting year and evaluating the real income theory. (Para 5 , 6 )
4. Under the mercantile system, income that becomes legally due during the accounting year accrues to the assessee, and subsequent unilateral relinquishment does not negate tax liability. (Para 5 , 6 )
5. Appeals allowed for assessment years where interest waiver occurred after the accounting year ended; appeal dismissed for the year where waiver occurred before year-end. (Para 8 )
6. How does the mercantile system of accounting differ from the cash system regarding the accrual of income?
Under the cash system, only actual cash receipts and payments are recorded. Under the mercantile system, credit entries are made for amounts legally due immediately upon accrual, regardless of whether they are actually received. (Para 6 )
7. Does the unilateral relinquishment of income after it has accrued under the mercantile system affect tax liability?
No. If income has already accrued to the assessee, a subsequent unilateral decision to give up that income does not escape the tax liability for the period in which it accrued. (Para 5 , 6 )
8. When can the concept of real income be applied to avoid tax liability on accrued income?
The real income concept applies where income did not actually accrue in reality. However, it cannot be used to defeat the provisions of the Act or the rules of the mercantile system. (Para 6 , 7 )
9. What is the legal distinction between waiving income before and after the end of the accounting year?
Waiver before the end of the accounting year may prevent accrual if the agreement alters the income. Waiver after the year ends occurs after the income has already accrued to the assessee. (Para 5 , 6 )
JUDGMENT
B.P. Jeevan Reddy, J.-These appeals are preferred by the Revenue against the judgment of the Punjab and Haryana High Court answering the questions, referred at the instance of the assessee, in favour of the assessee and against the Revenue. The questions involved in all these appeals are common. It would be sufficient if we take the case of one of the assessees, M/s. Shiv Prakash Janak Raj & Co. (P) Ltd. Four assessment years are relevant in this case, viz., Assessment Years 1968-69,1969-70,1970-71 and 1971-72. The two questions referred under Section 256(1) of the Income Tax Act, 1961 are:
"(i) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the interest for the assessment year 1971-1972, had already accrued to the assessee on October 31, 1970, under the mercantile system of accountancy ?
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the subsequent relinquishment of interest by a resolution dated November 24, 1970, did not affect the tax liability of the assessee on accrual basis?"
2. The partners of a firm, M/s. Shiv Prakash Janak Raj & Co. (the Firm), are also the shareholders/directors of the assessee-company. The assessee-company had advanced a loan to the firm. During the accounting year relevant to the Assessment year 1966-67, it charged interest in a sum of Rs. 25,048/- on the loan so advanced. Similarly, for the Assessment Year 1967-68, it charged interest in a sum of Rs. 25,843/-. For the four assessment years concerning herein, however, the assessee adopted a different course. (The accounting year adopted by the assesses was the year ending on 31st October 31. In respect of the Assessment Year 1968-69 (year ending October 31 1967], the assessee-company passed a resolution on October 9, 1967 [i.e., before the end of the accounting year] deciding not to charge interest from the firm in view of the difficult financial position of the firm. For the next, three assessment years, i.e., Assessment Years 1969-70, 1970-71 and 1971-72, similar resolutions were passed on February 26, 1969, March 16, 1970 and November 24, 1970 respectively. In other words, in the case of last three assessment years, the resolution deciding not to charge interest on the loan advanced to the firm was passed after the expiry of the relevant accounting year. Indeed, the resolution says that the firm had approached the assessee-company to waive the interest on the loan for each of the said years and that on such representation that the directors of the assessee-company (who were also partners in the said firm) decided that no interest shall be charged for each of the said three assessment years.
3. In the assessment proceedings relating to the said four assessment years, the Income Tax Officer took the view that inasmuch as the loans in question were interestbearing loans and because the assessee-company had relinquished the interest without any commercial considerations and further because the directors/shareholders of the assessee-company were interested in the firm, it was a case of collusion between them to evade the tax liability. Accordingly, he added an amount towards interest calculating it at the rate of fifteen percent per annum. On appeal, the Appellate Assistant Commissioner found that inasmuch as the resolution to waive the interest was passed after the expiry of the accounting year and further because the assessee-company was following the mercantile system of accounting, the interest must be held to have already accrued to the assessee before it was waived. He, however, reduced the rate of interest to nine percent. With that modification, he dismissed the appeals. The assessee thereupon filed a further appeal to the Tribunal but without success. The Tribunal observed that even though no entries were made in the books of the assessee-company or of the firm with respect to receipt or payment of in
